Currency Corner: hard times are coming for emerging-market currencies

Woman with renminbi © Getty images
Emerging-market currencies look set for a hard time against the dollar

I’m up here at the Edinburgh Festival presenting The Butcher, The Baker, The Brewer and the Market Commentator, in which Merryn and I discuss the issues of the day with interesting folk from the worlds of economics, finance and politics.

Yesterday we had Charlie Morris, who manages the Atlantic House Total Return Fund, and journalist Hamish McRae of Independent, Guardian and Evening Standard fame.

I was impressed with Hamish’s prediction in his book The World In 2020 that the UK would leave the EU – he wrote the book back in 1994.

But I wanted to share some of the conversation we had about currencies, in particular emerging market currencies.

Charlie Morris, normally so sensibly optimistic rather than blindly bullish, was making some rather bearish prognostications. He thinks emerging-market currencies are a big short.

By emerging-market (EM) currencies he means the likes of the Chinese renminbi, the Indian rupee, the Thai baht, the Indonesian rupiah, the Philippine peso, the Mexican peso and so on. Some have already moved, others less so, but the sector as a whole is a big short, he says, against our friend, the US dollar.

The change in trend in the US dollar – from sell signal to buy signal – is something we identified last week, and it has bearish implications for EM currencies.

“Dollar strength is never a good thing,” said Charlie. It places serious headwinds elsewhere.

He used the image of a large man jumping onto a waterbed. As he lands with a big splat, the kids all get thrown off. The big boys on the waterbed – the euro, and, to an extent, the pound – don’t move so much. But the little kids – the EM currencies – get thrown about.

When the big man gets off – when the dollar starts to fall – things can go back to normal again. But for now we have this problem of the big man landing splat on the waterbed. It’s a liquidity issue. When risk is off, as it seems to be now, everybody runs for the dollar. Thus there is a big disincentive to hang around in emerging market currencies.

Some have already fallen – the Argentine peso, for example – but others have moved less and there is still a long way for them to fall, especially if EM nations start cutting rates, as Charlie seems to think they soon will be.

“There are a lot of meetings coming up,” he said.

Over dinner that night, Charlie started listing out some trading ideas. The euro, he is not particularly worried about. It is one of the bigger boys on the waterbed. But the Chinese renminbi is re-setting lower. The Indian rupee, Indonesian rupiah, Philippine peso, Brazilian real and Mexican peso are all shorts against the dollar, he reckons, possibly the South African rand too, as probably the most liquid of the African currencies.

The Polish zloty is a short against the euro. The Norwegian krone could be a short against the euro, and the Canadian dollar too. (I found it interesting that he was thinking of shorting the commodity currencies against the euro.)

He thinks there is a huge opportunity shorting the Kiwi dollar against the US dollar. New Zealand is overvalued and its property market is a bubble waiting to burst.

And, as for the pound, what he calls “the Brexit trade” will be to buy the pound against the Swiss franc. The weakness in the pound is political, and when that resolves, it will rally.

But, as for the bigger picture, the fact that US 30-year bond yields are trading at less than 2% is telling you something. There are a lot of headwinds out there. Risk is most definitely off.

The big man is about to go splat on the waterbed.

Coming to the Edinburgh Festival?

MoneyWeek editor-in-chief Merryn Somerset Webb is back in the driving seat from Saturday, hosting  The Butcher, The Brewer, The Baker and the Commentator, in which we debate the issues of the day with leading thinkers from the world of politics, economics and finance.

Or there is my lecture Adam Smith: Father of the Fringe about the history of the Festival and how the Fringe proved the realization of everything Smith argued for. It’s in the very room where Smith completed Wealth of Nations.