EM FX: Greater divergences - BBH

According to analysts at BBH, we should see greater divergences within EM FX as the dollar has stabilized since the early 2018 swoon and the markets are finally starting to believe the Fed.

Key Quotes

“The dollar has stabilized since the early 2018 swoon.  Yet the greenback has been unable to fully capitalize on rising US rates.  The US 2-year yield of 2.38% today is the highest since September 2008, while the US 10-year yield of 2.83% is holding near the year’s high around 2.95%, which was the highest since January 2014.”

“The markets are finally starting to believe the Fed.  Fed Funds futures have fully priced in three hikes this year.  For 2019, two hikes are priced in compared to the Fed’s stated intent of three.  The breakdown is greatest for 2020, where markets are pricing in no hikes compared to the two seen by the Fed.”

“Major reasons cited for the dollar’s softness are the prospect of significant US twin deficits as well as heightened risks of a trade war.  It is the latter that poses the greatest risk to EM.  Even if the dollar suffers under the weight of growing twin deficits, EM FX will likely be impacted more by risks to global trade and growth.”

“We should see greater divergences within EM FX.  As such, we still believe it is very important for investors to continue focusing on country fundamentals.  Hedging out currency risk will not seem so important for US investors if the weak dollar environment comes back in play.  However, hedging will become more important if this dollar rally has legs.”