Emerging market funds adjust bets as ‘sell the dollar' trade loses appeal
T Rowe Price Group says it now favours US dollar-denominated emerging market bonds rather than local-currency ones as a tactical trade. Barclays is telling its clients to avoid shorting the greenback versus its Asian peers, while Fidelity International says the higher-for-longer US interest rates make it less attractive to borrow the US dollar to fund carry trades.
Fund managers and analysts alike are reappraising the 'sell the dollar' trade as the greenback's revival sapped some of the optimism towards developing-nation assets. Bets that the US dollar would continue to fall pushed the MSCI emerging market equity index to a more than three-year high last month, and a similar gauge of currencies to a sixth monthly gain in June.
'I'm weighted towards' US dollar-denominated emerging market bonds for now, given their attractive coupons, said Leonard Kwan, a fund manager at T Rowe Price in Hong Kong. There is likely to be a 'consolidative period for the dollar over the next three-to-six months', which will challenge the returns from local currency debt, he added.
Emerging market US dollar bonds outperformed their local currency counterparts last month, with a Bloomberg gauge of the securities returning 0.9 per cent, while one measuring local currency debt fell by the same amount.
A similar trend was seen in currencies. Bloomberg's US dollar spot index climbed 2.7 per cent in July, snapping a six-month losing streak, while MSCI's emerging markets currency index fell 1.2 per cent.
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The greenback tumbled last Friday (Aug 1) after soft US jobs data prompted traders to boost bets that the Federal Reserve will cut rates as soon as next month. The currency stabilised on Monday, with Bloomberg's gauge of the currency being little changed.
Long dollar
'We remain reluctant to jump into outright' trades betting the US dollar will weaken against Asian currencies into the summer, Barclays strategists including Lemon Zhang wrote in a Jul 24 note. 'Instead, we have recommended going long the US dollar against some low yielders in the region with stretched valuations and idiosyncratic risks,' such as the baht and Hong Kong dollar, they said.
Barclays also favours what it calls relative-value trades that avoid the US dollar altogether – such as betting that the Singapore dollar will weaken against its Chinese counterpart, and going short the baht versus the won.
Carry trades
Investors who have been using the US dollar as a funding currency for carry trades may also want to seek other options, according to Fidelity. Carry trades involve borrowing in a currency with relatively low interest rates and investing in another offering higher returns.
'Given that US dollar interest rates may remain relatively higher for some time, it may be worth considering alternative funding currencies that offer lower costs while maintaining similar risk profiles,' said Lei Zhu, head of Asian fixed income at Fidelity in Hong Kong.
Possibilities include borrowing in the Hong Kong dollar, which has lower short-term fund rates than the greenback, or even the yuan, she said.
Meanwhile, the US dollar's revival in July is making it cheaper for Asian funds to hedge their holdings of greenback-denominated assets.
The aggregate hedging cost for local currency funds, as measured by US dollar-Asia forward implied yields from eight economies and the equivalent US secured overnight refinancing rate, fell five percentage points last month, the first drop this year, data compiled by Bloomberg show.
'With the dollar strengthening again, unhedged or underhedged entities may view this as an opportunity to reduce their US dollar foreign-exchange exposure and to rebalance their positions,' Fidelity's Zhu said.
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