Emerging market currencies: Comeback kids
After a hammering from Donald Trump's election, emerging market currencies have sprung back in style. Paul McNamara from GAM talks to Katie Martin about Donald's dollar, global growth, and whether Tajik bonds are the latest sign of exuberance.
Presented by Katie Martin and produced by Aleksandra Wisniewska
Welcome to Hard Currency. I'm Katie Martin, and joining me is Paul McNamara, a portfolio manager from GAM who's here to shed some light on how emerging markets are faring at the moment. Paul, thanks for coming in.
And thanks for having me.
So it's not so long since Trump obviously was elected. And he was supposed to be this bogeyman for emerging markets, a huge risk to the asset class. How's that panned out from your perspective?
Well, so far it's been great for us. I think the big concern about Trump was specifically Mexico, but more generally he'd go after the manufacturing operations, the foreign investment by American corporations to manufacture abroad and import into the US. And so far, the couple of chances he's had-- he said he was going to name China as a currency manipulator on day one. He didn't do that.
He said he was going to withdraw from NAFTA. And although he's reiterated that threat recently, the first time he said it, he backed down. It comes down to the stuff that we were hearing yesterday that the Wall Street guys are kind of doing better than the racists in the current administration.
That's one way of putting it. But so your standard index of emerging market currencies, it took a heavy hit last November. But it's back and then some now. What are the kind of key markets for you of how EM currencies are doing in the wake of his election?
Well, from the immediate aftermath of the election, we're up about 20%, [INAUDIBLE]. There's some bond returns in there as well. All that we've seen is that Trump hasn't completely smashed everything up. And that was all we needed.
As long as we're in this low yield world, which is where we've been, emerging markets, which are high yielding currencies, where inflation is under control, were always likely to do well. And I think the extra ingredient we've had has been the weaker dollar. Emerging markets are sort of the counter dollar. For every 1% the dollar loses against the majors, it tends to lose about 1 and 1/2% against the EM index.
So a weak dollar environment is really the ideal environment. But more than anything, I think we've just discounted the huge amount of worries associated with the Trump administration.
So as a portfolio manager, how do you deal with that? You can't ignore him and just focus on the macro fundamentals. Or do you just ignore him?
Well, so far, ignoring him works until it doesn't. One of the best performing currencies since, say, three days after the election is the Mexican peso, because that's where the most worry was associated. The pattern does appear to be though that when he's under pressure, when President Trump is under pressure domestically, he's more likely to throw a bit of red meat to his base. And kind of going out, building the wall and so on seemed likely.
So I think the one approach is simply to buy the stuff that's most exposed to the Trump administration, which is obviously Mexico in the first, but also the Asian manufacturing countries. But the flip side of that is that if he actually does do some of the stuff he's threatened to do, those are the ones which are going to be hit worst.
So thinking of some of those currencies, to what extent are they doing well because the dollar is doing badly? And to what extent is it about the performance of global growth and of these individual economies?
Well, emerging markets are a growth asset class when the world is growing. And we've seen the closest thing we've seen to synchronised global growth since the crisis in recent years. So emerging markets have naturally done well.
They are also high yielding markets. And in this world where, unless things are actively imploding, the high yielders tend to perform. And as we've seen that high yield is no longer high yield, you don't get any returns from mortgages, you don't get returns anywhere else, more and more money has been pushed into emerging markets and emerging market currencies.
The weaker dollar is very important, or at least the absence of a strong dollar. But the total carry on EM since last November has been about 7%. But as I said, since the immediate aftermath of the election, we've returned closer to 20%.
So there's been real currency appreciation there. And emerging markets are seeing capital inflows. Almost every emerging market is beginning to rebuild currency reserves. So money's flowing into EM, which is a growth play.
So you've mentioned some of the bright spots there in terms of Asia and Mexico. But some of Europe's emerging market currencies are on a terrific run. And just like how EM generally is a kind of anti-dollar, if you like, are they kind of eurozone on steroids, eurozone on caffeine at least?
They tend to be. In general, say the Polish zloty, Romanian leu, Hungarian forint trade very much in line with Europe. And I think there was a lot of hope at the beginning of the year that they'd actually be sort of high [? beater ?] plays on the euro, because a lot of the manufacturing that used to be done in Germany is now done in central Europe.
As it's happened, with the exception of Romania, we have very populist governments across the region which want to keep policy loose, which are inclined to push for growth. So these currencies have done well. But they've pretty much performed in line with the euro.
Turkey is an exception. Turkey we think is an accident waiting to happen. But it's the high yielder. So since they hiked interest rates, that's had a very good year as well. And again, exports have been supported by strength in the eurozone. So when the eurozone is strong, that's definitely good for the euro region emerging markets.
There are some idiosyncratic stories there. You look at the Czech koruna, for example. That's been a very well-managed peg break, right?
Extremely well-managed. One of the things we tend to say about the Czechs is that they're kind of more German than the German, very high savings ratio, very manufacturing-oriented economy, very cautious policy. And it's somewhere that we tend find that continental European investors are very comfortable investing.
I think there was a lot of concern about the speculative positioning that went into the koruna, that they pretty much announced that they were going to break the peg in April. And then when they did actually remove the peg, I think there was a great fear that all this money would have to come out and we'd actually see the koruna trading weaker than the 27, which was where the peg was. Well, we're several months on from that. And actually, the koruna is about 3% stronger than it was.
So we've got through that worry. We've got an economy which is showing rare, in this world, signs of inflation where there's even genuine talk of hiking interest rates. So I think that that's [INAUDIBLE].
Imagine. How does that work?
I can't even remember that. [INAUDIBLE].
So what are the kind of clouds on the horizon? What are you worrying about? Or is it a case of while the music's playing, keep dancing?
That's something of a loaded phrase. Problem in asset management is it's very hard to be lagging a rallying market. And that does mean that as the rally continues, people get pushed more and more into the high yielder, higher risk markets.
And I think Turkey stands out for us as, I've said, an accident waiting to happen. You've got the classic signs of a lot of foreign borrowing by the banks, the banks pumping that money into property development, a very property-oriented financial sector, might be politely sort of termed a political institution that is not as independent as it might be of property development. We think that that could go wrong very quickly.
I think more broadly though it does come back to the US administration. We're seeing NAFTA back for renegotiation. If NAFTA goes, is the World Trade Organisation next? I think that's what worries us most.
The other thing is that the world and his dog hates the dollar now. And that tends to make it vulnerable. Because the US data has not been especially bad. And we had a weak patch.
It was out-and-out good yesterday.
Yeah. And we had a weak patch sort of Q2 going into Q3. The economic surprise index has now turned fairly decisively in the US. And if the world wakes up to the fact that the US data is actually strengthening, the US economy is in decent shape, we could see the dollar come screaming back. And that's never good news for EM.
But I come back myself to this idea that a little while ago, say four weeks ago, my inbox was just stuffed with notes telling me the end is nigh, sell everything. I just don't like how long the US stock market has been rallying for something's got to go wrong. That seems to have died down.
Where are you on this kind of scale of the end is nigh to everything is awesome? Because we've got Tajikistan coming to market soon. There's a lot of investors who can't point to Tajikistan on a map. But it will end up borrowing for, what, probably under 8%, right?
It's a mountain range borrowing a billion dollars basically, yeah.
So to what extent do you think this is kind of getting frothy? Or do you think that's kind of noise?
I think the Tajikistans and the 100-year Argentine bond, that's the sort of thing that people love to point to. But if you look at-- where you get a crisis is not in these very extreme sovereigns where there is kind of an investment case. They do tend to get rescued by the IMF. They very rarely default. What you tend to worry about is, say, when the Brazilian corporate sector, the stuff that people are comfortable, the stuff that people think should be investment grade when the money's sort of pouring in there. And we've seen a lot less of that. The Brazilian banks aren't borrowing, the Russian banks. Well, obviously sanctions are an issue there. We're seeing less money pouring into the flakier bits of emerging market. So I wouldn't say we're in everything is awesome mode. But our take on emerging market is that you need a really compelling reason not to get involved in something that's paying you 8%, 9%, 10%. And that compelling reason isn't there. As I said, I think the US administration is the most glaring potential problem. But it's just we don't see something going dramatically wrong. The big warning signs across most of the world just aren't there.
Yeah, fingers crossed, touch wood. So that's it from us. Paul, thanks very much. Keep an eye on ft.com/markets to keep up to date.