Table of Contents
- Overview
- Top Emerging Market Currencies
- Indian Rupee
- Brazilian Real
- South African Rand
- Indonesian Rupiah
- Emerging Markets Currency Index
- Historical Analysis
- 2023-2024 Outlook
- Emerging Market Carry Trades
- Understanding Carry Trades
- Top Opportunities
- ZAR/EUR
- BRL/JPY
- INR/CHF
- Risks and Challenges
- US Rate Policies
- China Slowdown
- Global Recession
- Choosing Optimal Currencies
- Investing Strategies and Tips
- Conclusion
Overview
Emerging markets currencies could offer compelling returns against developed market peers in 2024 as many countries show strong economic growth combined with higher real interest rates.
According to a Reuters poll of leading forex strategists, currencies across Asia and Latin America present attractive opportunities versus safe haven assets like the US dollar, especially if inflation continues moderating.
With tighter Fed policy and rising dollar strength throughout 2023, investors may want to already position in promising emerging market currencies that still appear substantially undervalued. These currencies offer much higher yield potential to compensate for elevated risk levels in developing economies.
Top Emerging Market Currencies
Several emerging markets currencies stand out as likely outperformers next year based on above-average growth forecasts and supportive monetary policy trajectories.
Indian Rupee
India's economy continues to achieve rapid expansion of around 6-7% annual GDP growth, emerging as one of the world's fastest growing major economies. The Indian Rupee is seen as substantially undervalued still on a purchasing power parity basis versus the US dollar.
As inflation comes under control through 2023, India's central bank is expected to pause interest rate hikes that helped support the currency this year. But real rates should remain comparatively high against developed markets, bolstering the appeal of INR for yield-seeking investors.
Brazilian Real
Brazil is recovering well from the impacts of the COVID pandemic, with its economy expanding nearly 3% this year. Brazilian Real volatility versus the USD has also moderated over the past year as the central bank completed its aggressive rate hike cycle.
With Brazil's benchmark Selic rate providing one of the highest real interest rates globally close to 12%, BRL still offers attractive carry trade appeal that should uphold its value despite Federal Reserve tightening.
South African Rand
South Africa's Rand has been lagging this year despite the country's strong terms of trade and massive current account surplus amid high commodity export values. However, having reached historic lows, technical analysis suggests the ZAR is primed for a rally after years of declines.
In addition, South Africa still boasts the highest real interest rates globally above 5%. As the SARB maintains rates at elevated levels, the yield advantage should combine with improving economic fundamentals to offer investors sizable upside potential.
Indonesian Rupiah
Indonesia's central bank has taken a measured approach to tightening so far in 2022, avoiding the hyper-aggressive hikes undertaken by Western peers. This has prevented excessive volatility and downside damage across Indonesian markets.
Structural current account deficits caused by oil imports have also narrowed substantially in 2022 as energy prices moderate. With inflation appearing to peak and starting to ease as well, IDR should gain stability after declines this year.
Emerging Markets Currency Index
The MSCI Emerging Markets Currency Index provides a benchmark designed to track leading emerging market currencies versus the US dollar. The index has faced substantial pressure in 2021-2022 amid aggressive Fed tightening and recession risks, declining over 15%.
Historical Trends
However, analyzing performance historically offers perspective on recovery potential. Going back to 2001, the index has achieved compound annual growth above 2% over the past 20 years despite multiple crises across developing economies causing periodic drawdowns.
2023-2024 Outlook
As most analysts forecast global growth bottoming/rebounding from mid-2023, emerging currencies could stage a sustained turnaround. Though risks remain, leading EM currencies still offer higher yield potential than mature markets to compensate investors.
Upside potential appears especially strong in Latin American and select Asian currencies based on monetary policy trajectories.
Emerging Market Carry Trades
Understanding Carry Trades
Carry trades are a popular strategy that exploits differences in interest rates between currencies to earn a yield spread. Traders essentially borrow or short low-interest rate currencies to fund purchases of higher-yielding currencies. As exchange rates fluctuate, traders attempt to capture yield differential gains.
Top Opportunities
Several specific emerging vs developed market currency pairs highlighted recently offer attractive carry trade potential for 2023-2024:
Long ZAR/Short EUR
With South Africa's real interest rates exceeding 5% while Eurozone rates remain negative, this cross offers tremendous yield appeal right now. The EUR downtrend against the USD provides added advantages for traders seeking ZAR upside exposure.
Long BRL/Short JPY
A similar dynamic applies with Brazil's 12% real rates looking extremely compelling funded in ultra-low yield yen used for a short position. The BOJ's persistent dovish policies means negative rates look assured in Japan for years to come still.
Long INR/Short CHF
While India's real rate around 2% lags other EMs, that still dwarfs Swiss rates which remain negative currently. With the SNB prioritizing currency intervention too, traders can exploit substantial yield differentials through this carry trade.
Risks and Challenges
While emerging market currencies offer substantial upside potential, risks factors that could spark pullbacks include:
US Rate Policies
If the Federal Reserve is forced to take interest rates higher than currently anticipated to tame inflation, EM currencies would likely face renewed downside pressure.
China Slowdown
With China such a dominant economy and driver of global trade and commodities demand, an accelerated mainland growth slowdown would also negatively impact emerging market dynamics.
Global Recession
In the worst case scenario where 2023 brings deepening worldwide recession rather than recovery, risk-off sentiment would spark capital outflows from developing economies, causing EM currency depreciation.
Choosing Optimal Investment Currencies
While the highest potential individual emerging markets like India and Brazil clearly warrant investor attention, maintaining diversified exposure is always prudent as well.
This can be achieved through ETFs tracking benchmarks like:
- MSCI Emerging Markets Currency Index
- JP Morgan Emerging Local Markets Index
- WisdomTree Emerging Market Ex-State-Owned Enterprises Fund
When selecting single currencies to invest in, optimal choices would meet criteria such as:
✔️ 5%+ GDP growth over next 1-2 years ✔️ Stable or steadily improving business environment ✔️ Consistent current account surpluses ✔️ Supportive central bank policies ✔️ Substantial real rate differentials vs funding currency
Investing Strategies and Tips
For traders looking to deploy capital into emerging markets currencies, key tips include:
- Use a broker with competitive forex spreads, fair pricing and sound execution
- Apply prudent stop loss orders for risk management
- Hedge exposure via diversified EM currency funds
- Maintain updated watchlists tracking macro news and data
- Focus deployment during market pullbacks
- Consider a basket approach across multiple EM currencies
Conclusion
While risks exist around things like the Fed’s direction or recessions, leading emerging market currencies still offer much higher return potential than mature economies, along with higher yields. As the US dollar bull market starts fading, their outperformance could just be getting started as we head into 2024.
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