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EM FX Summary - 25 October 2017

Core Content

This report provides an analysis of the Emerging Markets (EM) Foreign Exchange (FX) outlook, based on a marketing trip to New York, Boston, Toronto and Montreal. It highlights the differing views among real money/pension fund accounts and hedge fund accounts, and presents key insights on specific EM currencies and broader market dynamics.

Main Takeaways

• Dichotomy in EM FX Outlook: There is a clear divide between real money/pension fund clients, who are generally constructive and increasing EM FX allocations, and the fast money/hedge fund community, which is more cautious due to near-term risks.
• Uncertainty in Near-Term Outlook: The uncertainty around the Federal Reserve chair selection and US tax reform has led to a more selective EM FX view, with limited positioning from the fast money community.
• Valuation and Inflows: EM FX valuations remain attractive, and inflows have supported EM currencies despite short-term dips. The EM-DM growth differential is widening, which should continue to support inflows.
• Macro Vulnerability Reduction: EM macro vulnerabilities have decreased significantly since 2013, with real rates now higher for most EMs, particularly high yielders.

Key Currencies Analysis

RUB (Russian Ruble)

• Strong Position: RUB is considered one of the better carry longs in EM FX due to its strong defensive metrics.
• Support Factors: The current account is in good shape, real rates are high, and FX reserves are large.
• Resilience: RUB is expected to be more resilient to external shocks, including higher US rates.
• Valuation: While RUB had previously been undervalued, current valuations are not a hindrance to appreciation.
• Fiscal Stability: Oil prices in RUB terms are above budgeted values, reducing fiscal concerns.
• Recommendation: The report recommends a long position in RUB against USD and CAD.

TRY (Turkish Lira)

• Mixed Views: There is significant disagreement among clients regarding TRY.
• Opportunities and Risks: Some see recent weakness as an opportunity to re-enter longs, while others view it as 'un-tradable' due to headline risks and poor defenses against external shocks.
• Positioning: Positioning in TRY is relatively clean, with no significant long or short bias.

ZAR (South African Rand)

• Mixed Views: Similar to TRY, views on ZAR are mixed.
• Beta to US Rates: ZAR has the highest beta to US rates/USD among EM FX currencies.
• Political and Fiscal Uncertainty: Concerns around the December ANC election and fiscal slippage.
• Underperformance: ZAR has underperformed significantly since September 8th, with a 7% depreciation.
• Positioning: ZAR is seen as a vehicle to express a bearish EM near-term view or provide protection for other EM longs.

ILS (Israeli Shekel)

• Overvaluation: ILS is currently overvalued, with valuations reaching the highest levels in the past 15 years.
• Tactical Short View: The report suggests a tactical short position for ILS due to stretched valuations, subdued core inflation, and the potential for FX interventions.
• Performance: ILS has outperformed since US yields bottomed on September 8th, but this may not be sustainable.

Most Discussed Charts

• Figure 1: EM inflows were larger before the taper tantrum than recent flows.
• Figure 2: EM stocks look cheap and under-owned.
• Figure 3: EM FX is still cheap on trade and capital-based valuation metrics.
• Figure 4: EM FX valuations on the DBeer model indicate more room for appreciation.
• Figure 5: TRY, MXN, MYR, and COP are cheap on both capital and trade-based valuations.
• Figure 6: The 'new' spiral chart shows weighted valuation ranks for EM FX.
• Figure 7: The EM-DM growth differential is widening, supporting continued inflows.
• Figure 8: EM macro vulnerability has significantly reduced since 2013.
• Figure 9: Real rates are now higher for most EMs, particularly high yielders.
• Figure 10: The basic balance has improved for most EMs, reducing dependence on portfolio flows.
• Figure 11: THB and RUB have the best defensive metrics, while TRY and ZAR are the worst.
• Figure 12: RUB is supported by high real rates, likely to remain so over the next year.
• Figure 13: MXN was the best hedge in EM FX as of January 16.
• Figure 14: ZAR currently ranks as the best hedge in EM FX.
• Figure 15: ILS has outperformed since US yields bottomed on September 8th.
• Figure 16: ILS is the most overvalued in the past 15 years on the DBeer metric.

Additional Information

• The report includes important disclosures regarding the source of information, potential conflicts of interest, and the nature of recommendations.
• Deutsche Bank is not acting as a financial adviser, and the information is provided for informational purposes only.
• The report is subject to change and does not take into account the individual investment objectives, financial situations, or needs of clients.

Key Analysts and Teams

• Gautam Kalani, PhD – EM FX Strategist
• David Folkerts-Landau – Group Chief Economist and Global Head of Research
• Raj Hindocha – Global Chief Operating Officer
• Michael Spencer – Head of APAC Research and Global Head of Economics
• Steve Pollard – Head of Americas Research and Global Head of Equity Research
• Anthony Klarman – Global Head of Debt Research
• Paul Reynolds – Head of EMEA Equity Research
• Dave Clark – Head of APAC Equity Research
• Pam Finelli – Global Head of Equity Derivatives Research
• Andreas Neubauer – Head of Research - Germany
• Spyros Mesomeris – Global Head of Quantitative and QIS Research

Summary

The report emphasizes the mixed outlook for EM FX, with real money and pension funds more optimistic about EM FX appreciation, while hedge funds are more risk-averse. RUB is highlighted as a strong candidate for long positions due to its defensive metrics and macro support, while TRY and ZAR show mixed views and are seen as more vulnerable. ILS is considered overvalued and a tactical short is recommended. The report includes a range of charts and data to support these views, with a focus on valuations, macroeconomic conditions, and external risks.