HSBC Sage Flags Emerging-Market Pullback on Dollar

By Ye Xie

HSBC Holdings Plc (HSBA), which in February foresaw the longest emerging-market currency rally in five years, says it’s time to pull back as increasing signs of U.S. growth support the dollar.
HSBC, which operates in 74 countries worldwide and gets more than half its revenue from emerging markets, recommends clients reassess their investments in South Africa’s rand, Russia’s ruble and Mexico’s peso. A Bloomberg index of 20 developing currencies has slipped 2.1 percent in the past two weeks, retracing half its gains from February to July.
“The tide is turning,” David Bloom, HSBC’s global head of currency strategy in London, said in an Aug. 5 phone interview. “It’s a mini-wobble in emerging markets. Be careful.”
When Bloom said six months ago it was time to get back into emerging markets after the biggest rout since the financial crisis, rivals from Deutsche Bank AG to Goldman Sachs Group Inc. said it was too soon. This time, he’s part of a growing consensus, as the prospect of higher U.S. interest rates sucks investment away from developing economies already hurting
from conflicts in Ukraine and Gaza.

Diverging Currencies

The dollar has risen versus 29 of 31 major currencies tracked by Bloomberg since the end of June, after falling against all but six since late January.
Bloomberg’s index, which tracks the biggest emerging-market currencies, from Brazil’s real to the rand and Polish zloty, has tumbled since July 23, paring a 2.4 percent advance from its Feb. 3 low. The gauge fell 1.2 percent in July, its first monthly pullback since it plunged 3 percent in January.
To Bloom, whether the declines turn into a mass exodus by investors depends on what happens to volatility.
Bigger price swings as the Federal Reserve tightens monetary policy and diverges from peers such as the European Central Bank may threaten profits from carry trades, where investors borrow in currencies where rates are low and reinvest the proceeds where they are higher, typically emerging markets.
“The danger for emerging markets is volatility on long-term U.S. rates moves up,” Bloom said. “If the long rates pick up, then it’s going to be a full-blown dollar rally and EM will be hit hard. The dollar is ready for lift-off.”

Losing Trade

JPMorgan Chase & Co.’s Global FX Volatility Index rose for the past four weeks, climbing from a record low on July 3 in the most sustained run of increases since December.
Carry traders who sold the dollar and euro to buy a basket of five currencies including Argentina’s peso and Indonesia’s rupiah would have made almost nothing since the start of July, after receiving 9.2 percent from February to June, data compiled by Bloomberg show.
Societe Generale SA, which in February followed Bloom’s bullish call by recommending Turkey’s lira and Mexico’s peso, said yesterday that clients should bet on the rand weakening and becoming more volatile over the next three months. Days earlier, it ended a recommendation to buy Hungary’s forint with a loss of about 1 percent.
“While the rand is somewhat sheltered geographically from Russia and Ukraine tensions, continued” declines in South African bonds as the Fed prepares to normalize policy “may destabilize already weak bond inflows and undermine the currency,” Phoenix Kalen, a strategist at SocGen in London, wrote in a report to clients.

‘Distinct Channels’

Volatility is still about the lowest ever and investors remain willing to seek higher yields while U.S. rates remain in their record-low zero to 0.25 percent range, Koon Chow, a strategist at Barclays Plc in London, said in a July 31 note to clients. Futures show traders don’t expect the Fed to raise its benchmark until at least mid-2015.
“The climate of low global market volatility and low yields in many developed fixed-income markets should continue to push portfolio capital out to EM,” Chow wrote. Gains in the dollar will help differentiate currencies “rather than combine to push EM local markets generally weaker,” he wrote.
Adding to the pressure on emerging-market currencies are escalating tensions in Ukraine, with the U.S. warning yesterday about the risk of Russia massing troops on its western border. Russia said reports of a military build-up were “groundless.” President Vladimir Putin yesterday ordered restrictions on food and agricultural imports for one year from countries that have imposed or supported sanctions against Russia for supporting the rebellion in the former Soviet republic.
A 72-hour truce in Gaza held into its third day today, raising hopes of a lasting end to a conflict in which at least 1,868 Palestinians and 64 Israeli soldiers have been killed.

Leading Retreat

Russia’s ruble led the retreat among developing-nation currencies in the past month, with a 5 percent drop against the dollar. The ruble is one of the currencies HSBC’s Bloom identified this week as a likely victim of rising volatility, along with the rand and the pesos of Mexico and Colombia.
Bloom made his prediction about the recent rally in a Feb. 6 interview with Bloomberg News in Cape Town. He also forecast the emerging-market selloff that preceded those gains, saying in October that trade deficits would cause problems for some currencies. That same month, he failed to predict the slide that sent the rand to a record-low in January.
Citigroup Inc., the largest foreign-exchange trader, downgraded their view on developing currencies on Aug. 5. The $4.6 billion iShares JPMorgan Emerging Markets Bond Exchange Traded Fund (EMB), the most-active fund of its type, lost $205 million on Aug. 1, the biggest one-day outflow since its inception in 2007, data compiled by Bloomberg show.
DWS Investment GmbH, which oversees $1.3 trillion from its headquarters in Frankfurt, said it’s turning against the rand, Brazilian real, South Korean won and zloty.
“The discussion of the rate hike in the U.S. is negative for emerging-market currencies,” Roland Gabert, who oversees developing-nation assets for the company, said by phone on Aug. 5. “Investors are afraid of risks right now.”