Since our last update in late February, the Covid19 pandemic has devastated the EM space as investors have picked up stakes and run for cover, leaving EM assets and currencies in a woeful state. Credit spreads have blown wider and EM central banks on balance continue to cut rates to support their economies rather than fretting the instability or inflation from the risk contagion or inflation. We focus on CEE currencies, especially HUF, in this report after Hungary, nominally an EU country, has granted its Prime Minister Viktor Orban the right to rule by decree indefinitely.
The Covid19 crisis continues to present risks to the EM complex and currencies and the EM policy response of continuing to cut local policy rates even as currencies come under severe strain is at odds with historic behavior. Therefore we are in favour of minimal to no exposure to carry trades at this time and will look to bargain hunt once it is clear that the Covid19 crisis is ebbing and some sense of normalcy is returning and/or if market disorder worsens materially and EM central banks begin to move more forcefully in support of their currencies.
YTD EM Carry trade performance in 2020.
Below is a snapshot from a Bloomberg tool for measuring FX carry performance, a snapshot we will release with every update this year for a sense of how carry trades have performed in broad terms. The given basket here is for the higher yielding of the (formerly fairly liquid) EM currencies against the formerly lowest yielding G10 currencies, though in the latter camp, no country features a policy rate above 0.25% now.
This basket returned nearly 15% in 2019 due to that year starting at a very low point for global risk appetite. After a strong start to 2020 on an extremely supportive backdrop in financial conditions, the basket has now given up all those gains and effectively also the gains from 2019, even adjusted for carry. Note that the benchmark – the MSCI EM equity index in USD terms – has dropped some 25% on the year after a drawdown of some 33% at its worst point.