EM: Focus on fundamentals as opposed to high carry - BBH

According to analysts from Brown Brother Harriman, the corrective rally in emerging markets (EM) run out of steam in May as the US dollar resumed the upside. They favor the currencies of Asia.

Key Quotes:

“The EM FX corrective rally ran out of steam in May.  EM FX had gotten some traction earlier this year as markets pushed out Fed tightening prospects.  However, FOMC minutes and Fed official comments this month have led markets to reprice their dovish view on the Fed.” 

“The dollar’s appreciation trend resumed as Fed tightening expectations have picked up.  Our base case is a June or July hike.  As such, we will retain a defensive posture with regards to EM as the June 15 meeting approaches. Furthermore, the Brexit vote on June 23 also has potential to boost market turbulence as we get closer.”

“We still recommend investors to focus on fundamental factors.  With a negative EM environment likely to ultimately prevail (slow global growth, low commodity prices (ex-oil), rising US rates, and a strong dollar), we feel that high carry will do very little to protect those currencies that are most vulnerable.”

“We favor the currencies of Asia and, to a lesser extent, EMEA, while Latin America should continue to underperform.”

“With global financial markets likely to come under stress again, we recommend focusing on fundamentals as opposed to high carry.  Note that three of the five top currency picks for Q2 2016 are in Asia (SGD, PHP, and THB).  This lines up with our long-held view that Asia is best-placed fundamentally in the current environment.  Three others in the top ten are also from Asia (CNY, KRW, and TWD), along with four from EMEA (RON, ILS, CZK, and HUF).”