FX Dashboard: Leaders and Laggards in EM FX as US Yields Retreat from the Peak

After consistently drifting lower this month, the dollar took a breather today as the dollar index (DXY) was flat for the day. Similar to the dollar, EM currencies were also flat on average. Even within EM, there were few outliers as most currencies were within 0.3% of their respective yesterday’s closes. Although there was little dispersion within EM today, for the month as a whole the picture is different.

The US 10y yield peaked at 1.75% at the end of March and has dropped to 1.60% since then even as the incoming activity and inflation data in the US have surprised on the upside, indicating that the reflationary scenario is priced in. The dollar has weakened by 2.3% this month on a combination of the drop in US long-end yields and vaccine supply constraints in Europe finally getting resolved.

With the dollar weakening, EM currencies have appreciated 1.5% on average. As EM currencies have around from their weak performance in Q1, there has been a fair amount of differentiation among EM countries. To highlight this differentiation, we plot the performance of EM currencies against their respective betas in the chart below.

The currencies that stand out as underperformers are:

• The Indian rupee (INR): Indian equities and the currency have taken a hit after a sharp ramp-up in coronavirus cases and hospitalizations, rekindling economic worries. Earlier this year, it appeared that India had managed the pandemic well. However, the picture changed dramatically over the past month as the country now has the highest daily cases in the world. Worsening the picture is the upcoming state election in West Bengal, which is currently the singular focus for Prime Minister Modi.
• The Russian ruble (RUB): The ruble has been lagging other currencies and oil prices in anticipation of US sanctions. As we discussed in our trade recommendation note yesterday, with the sanctions now behind we expect the currency to begin to catch up to its peers although risks at the Ukraine border remain.
• The Indonesian rupiah (IDR): The rupiah has taken a hit from the uncertainty created by President Joko Widodo’s announcement of a potential change to the central bank’s mandate to include economic goals. Given the importance of bond inflows, we would expect the legislation to be diluted or postponed. Moreover, Bank Indonesia lowered their economic growth forecasts but held rates steady with currency stability in mind. Instead, they opted for macroprudential measures to spur lending. With IDR already reflecting the negative scenario, we have recommended a trade to be long IDR vs the Singapore dollar (SGD).

The currencies that have outperformed in the rally are:

• The Israeli shekel (ILS): After reaching its strongest nominal level in over 25 years in January, the shekel weakened as the Bank of Israel embarked on a massive intervention program and the inconclusive fourth election in two years added to the weakness. In a recent note, we argued that if the currency continues to depreciate, we would be looking for an entry point for a long recommendation on the back of the expected bounce in growth and a wide current account surplus. Some of the underperformance appears to have reversed already.
• The South African rand (ZAR): The rand has been the best performer among EM currencies over the past year, helped by the rally in commodities supporting its current account and a hawkish central bank. As mentioned above, we have recommended a long RUB vs short ZAR trade as these supportive developments are priced in the currency in our view.
• The Chilean peso (CLP): The dollar weakening has once again propelled copper price close to its decade-high levels, supporting the peso. Additionally, despite the recent rise in coronavirus cases, the country leads the region with its rapid pace of vaccinations, setting up the conditions for a strong economic rebound.
• The Peruvian sol (PEN): The currency was expected to be volatile going into the presidential election as has been the case. As we head to the second round in June between an extreme left-wing and a right-wing candidate, the volatility will likely pick up further as we discussed in a recent note, which may present an opportunity along the way.

Data Source: Refinitiv; Note: EM refers to an index created from equally weighted spot returns for 22 EM currencies

Best Longs / Best Shorts

• From our list of underperformers in the attached FX Dashboard, we removed the Israeli shekel (ILS) as its z-score receded.
• The list now consists of the Romanian leu against the euro (EURRON) and the Thai baht (THB).
• Our list of outperformers is unchanged with the South African rand (ZAR) and the Chilean peso (CLP) on it, in line with the discussion above regarding currencies that have outperformed.

Best Crosses

• Our list of preferred relative-value trades shrunk to Short ZAR vs Long THB or Indian rupee (INR) or RUB or the Indonesian rupiah (IDR).
• The 3m expected returns for these pairs have dropped but are still high in the range of 9.5-10.0% (not annualized), assuming mean reversion.