EMD Relative weekly notes: Week Ending July 10, 2020

Currencies chasing COVID-19?

While currencies have generally begun to recover some of the deep losses of the peak virus period, over the past month Asian currencies have done particularly well, while Latin America has generally lagged. This may partially reflect economic recovery fears for the region and stabilizing risk appetite, but positive real rates and expansive DM monetary policies argue for an eventual strong recovery.

Over the past month, there has been a fairly striking regional definition to total returns in the EM Local space, with Asia well out-performing Latin America, despite that region's higher nominal and real interest rates, in general (see Figure 1). In a market characterized by a highly accommodative developed market monetary policy, this is somewhat unusual.

Figure 1


Source: Bloomberg, as of July 10, 2020. Past performance is no guarantee of future results. Performance for other time periods would differ.

We believe one of the reasons is the strong divergence between the regions in recovering from the COVID-19 slowdown. It seems clear that negative economic surprises are less likely out of Asia as those economies open up in a fairly steady pattern.

Secondarily, as equity markets have begun to register less robust gains, that lower risk appetite seems to have been focused on Latin America for EM investors. While 3-month returns are in double-digits over major US indices, only the NASDAQ has registered a positive gain in the last month. 

With that sensitivity Latin currencies may pause in their recovery off the lows, but the level of policy support from developed markets historically will mean an eventual robust recovery. With broadly the most positive real rates in the asset class and the deepest levels of under-valuation, these have become notably cheap assets.