Love for EM carry continues to thrive but for how long?

EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp

RAMYA RS
Analyst
DIFC Branch – Dubai
T:+971 (4)387 5031
E: ramya.rs@ae.mufg.jp

LEE HARDMAN
Senior Currency Analyst
Global Markets Research
Global Markets Division for EMEA
T: +44(0)20 577 1968
E: lee.hardman@uk.mufg.jp

PAUL FAWDRY
Head of Emerging Markets FX Desk
Emerging Markets Trading Desk
T: +44(0)20 577 1804
E: paul.fawdry@uk.mufg.jp 

MUFG Bank, Ltd.
A member of MUFG, a global financial group

Macro focus

This year’s winning EM carry trade strategy may still have some room to run work given a peaking rate cycle (see here and here). Yet, apprehensions are rising. The easy part of disinflation is mostly over with the fall likely slower going forward given the lack of favourable base effects and quietly rising energy prices. Also, EM central banks have begun loosening monetary policy rather abruptly ahead of DMs, which may lower the yield on offer rapidly and weigh on currencies (see here). On net, whilst we do not want to lean against the wind during the more indolent summer period given the robust momentum behind the carry trade, but we would take some insurance against what could be an eventual final months of 2023 given the challenging growth-inflation combination.

 

FX views

The recent messaging from the Fed reinforces that it is soon to end raising rates, if not having done so already. This is encouraging for EM FX, but we would caution that this is insufficient for these currencies to strengthen with other developments still needed. With the conditions absent for a more powerful performance for the better (or worse), it makes sense how a broad measure of EM FX has been tracking the USD this year. However, this masks a couple of ongoing developments. The regional divergence in terms of performance has remained stark. The resilience of the LatAm and CEE3 region has persisted compared to a lacklustre showing by EM Asian currencies. Meanwhile, against a setting of a benign DXY and policy rates remaining high in some places, carry has also continued to perform well.

 

Week in review

Headline inflation in Turkey rose by 9.6pp to 47.8% y/y in July, precisely in line with our expectations (consensus 46.9% y/y), driven by the fading of favourable base effects and strong sequential price pressures. Czech Republic kept rates unchanged at 7.00% as expected and formally ended the FX intervention regime announced in May 2022. Finally, against the highest rate of inflation on record, Egypt surprised us (and markets) by raising rates by 100bp to take the overnight lending rate to 19.25%.

 

Week ahead

This week, we will have the rate meeting in Romania (MUFG and consensus on hold at 7.00%). July inflation statistics will be released in Hungary (MUFG 17.8% y/y; consensus 17.7% y/y), Russia (MUFG 4.2% y/y; consensus 4.3% y/y), the Czech Republic (MUFG and consensus 8.8% y/y) and Romania (MUFG 9.5% y/y; consensus 9.7% y/y).

 

Forecasts at a glance

In a world of tightening global financial conditions and questions about the liquidity implications of the now-finalised US debt ceiling, we see a degree of macro risks for EM economies in H2 2023, with external funding requirements the central concern. We expect EM growth to trough this year but remain below potential in the 2024 recovery. The silver lining is that subdued growth should cap inflation, facilitating monetary policy easing where external balances allow.

 

Core indicators

According to IIF data, EM funds witnessed a net inflow of USD0.4bn in the week ending 2 August, with the inflows into EM equities (USD0.5bn) offsetting minor outflows from EM bonds (USD0.1bn).