The bank is now bullish on this asset class. The question is, should you get in on this trade?
Morgan Stanley (NYSE: MS) has a trade suggestion that might surprise you.
According to the bank, the U.S. dollar is likely already in a bear market, which means now is the time to get in on emerging market currencies despite a weaker outlook for global growth.
The dollar took a stumble last week after the Fed reinforced expectations that it may cut interest rates at its meeting next month and potentially deliver one more rate cut later this year. A weaker dollar is typically favorable for emerging market assets because it makes it easier to service dollar-denominated debt.
“We are bullish,” wrote a team of analysts led by James Lord, Morgan Stanley’s London-based head of fixed income strategy, in a note to clients earlier this week. “Emerging-market currencies have lagged, but with growing conviction that the dollar has turned, we think that a catch-up is under way.”
This call comes at a time when an index of emerging market currencies nears its highest level since April, even as geopolitical tensions rise in the lead-up to the much-anticipated G-20 meeting and as the world’s largest central banks switch to a more accommodative policy.
The iShares MSCI Emerging Markets EEM ETF is up more than 5% since the end of April, contributing to its 10% gain so far this year, after bouncing back from a -17% fall in 2018.
With the Fed now “emphasizing the weakness in global growth,” a more dovish policy approach may hep mitigate “the tail risks around G-20 outcomes,” the analysts wrote.
“The rest of the year will continue to be a balancing act for emerging markets, between central bank accommodation and the outlook for global growth,” said Christopher Shiells, emerging market analyst at Informa Global Markets.
Shiells believes that in order for emerging market currencies to continue to rally, the Fed will need to continue to signal a neutral stance and respond with rate cuts if the U.S. economy shows signs of slowing.
Morgan Stanley’s favorite emerging market currency is the Russian Ruble, which is the best performing developing market currency so far in 2019. The bank is also long a basket of Latin American currencies and is betting on further gains for the Indian rupee.
But Pimco’s Gene Freida warns investors to pause before loading up on emerging market currencies.
The strategist said in an interview at the Bloomberg Emerging & Frontier Forum in London on Tuesday that, while he would love to load up on risk assets and ride the rally that accompanies a cycle of U.S. rate cuts, he’d do so “only very cautiously.”
“Growth is weak enough that, if it had another shock, it could put the global economy into recession,” Freida said. “We have generally been constructive for a while on emerging-market currencies but we feel like we’re very close to a pivot point.”