Analysis: Investors look to emerging markets as planets align for end of dollar bull market

NEW YORK, Dec 6 (Reuters) – As the U.S. dollar tumbles from multi-decade highs, some investors are betting that emerging market currencies will be big winners from a sustained dollar turnaround.

The MSCI International Emerging Markets currency index (.MIEM00000CUS) is up nearly 5% from its lows and posted its best monthly gain in about seven years in November as expectations that the Federal Reserve will soon slow the pace of its rate hikes, the case for investors betting on emerging market currencies.

Signs of a broader turnaround in dollar sentiment are visible in the greenback’s 8% decline against a basket of developed market currencies from its September highs. In November futures markets, speculative traders swung to a net short position on the US dollar for the first time in 16 months, calculations by Reuters based on data from the US Commodity Futures Trading Commission showed.

“The planets are lining up for a dollar bear market,” said Paresh Upadhyaya, director of fixed income and currency strategy at Amundi US.

Emerging market currencies have outperformed their developed market peers this year, with MSCI’s index of emerging market currencies down 5% year-to-date, while the dollar’s G10 peers have lost almost twice as much.

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EM currencies recover

In addition to the possibility of slower Fed hikes, investors cited expectations that China will ease its strict COVID-19 containment policies and relatively rich yields found in many EM countries as reasons for adding positions in emerging market currencies.

Amundi’s Upadhyaya focuses on the currencies of high-yielding emerging market countries that have balanced current accounts and smaller budget deficits, including the Brazilian real , Peruvian sol = and Indian rupee .

Some emerging markets offer attractive returns, even adjusted for inflation. For example, the inflation-adjusted yield on US 10-year Treasuries is at 1.08%, compared to 6.07% for the Brazilian equivalent.

CHINA WATCH

Investors cheered the prospect of a shift in China’s COVID-19 policy, after rare street protests increased pressure on officials to ease some rules. China – the world’s second-largest economy and a key consumer of the commodities produced by many emerging market countries – is set to announce a further easing of its COVID curbs as early as Wednesday, sources said.

The Chinese yuan has risen about 5% against the dollar since the end of October and posted its best weekly performance against the US currency in at least two decades on Friday, while the Hang Seng Index gained 27 in November, its best month since October 1998. % rose.

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“I think the cat is out of the bag. They can’t go back to their purely restrictive zero COVID policy,” said Jack McIntyre, a portfolio manager at Brandywine Global.

McIntyre increased exposure to some Asian currencies, including the Thai baht and the Malaysian ringgit. Thailand’s currency rose 8% in November, while the ringgit gained 6%.

Some investors think it may be too early to bet on a sustained dollar turnaround. While Fed Chairman Jerome Powell said last week it was time to slow the pace of upcoming rate hikes, the central bank could raise rates further than previously expected as it battles the worst inflation in decades.

At the same time, signs of stubborn inflation in next week’s US consumer price data could reignite bets on Fed falsity and boost the dollar.

Investors generally expect the Fed to raise rates by 50 basis points next week, following a spate of 75 basis point rate hikes.

Conversely, the tightening by central banks around the world could also trigger a global recession, a scenario that some say could hurt emerging market currencies and help the dollar.

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A global slowdown “will create a safe-haven bid and limit the ability of most cycle-sensitive currencies to recover against the dollar,” said Aaron Hurd, senior portfolio manager, currencies, at State Street Global Advisors.

However, others are betting that China’s reopening is good for certain emerging market currencies.

Carlos Fernandez-Aller, Head of Global FX and EM Macro Trading at Bank of America, sees an eventual reopening of China boosting the Thai baht, which he believes will benefit from an increase in tourism.

Analysts at Société Générale, meanwhile, said an easing of China’s COVID restrictions could boost the South African rand, forecasting an 18% increase in total return terms for the commodity exporter’s currency next year.

“Improvements in fundamentals, valuations and technicals make the case for stronger EM FX performance over the next year,” they wrote in a recent report.

Reporting by Saqib Iqbal Ahmed in New York Additional reporting by Davide Barbuscia in New York Editing by Ira Iosebashvili and Matthew Lewis

Our Standards: The Thomson Reuters Trust Principles.

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