JPMorgan Flags Geopolitics as Reason to Sell Emerging Markets

The outlook for emerging market currencies is looking bleaker for JPMorgan Chase & Co.

Strategists Jonny Goulden and Saad Siddiqui recommended cutting emerging market currencies to underweight. The bank cited tensions in Russia as part of the reason behind the move. Domestic policy in Turkey and Brazil, and slowing growth and portfolio flows in China were also among challenges noted by the bank.

Those issues are compounded by the U.S. dollar’s rebound this year, spurring losses for 22 of the 24 emerging currencies tracked by Bloomberg. Rising Treasury yields have also dragged developing nations’ borrowing costs higher and inflicted pain on their local debt, where year-to-date losses stand at 24% for Nigeria, 16% for Turkey and 13% for Brazil.

“EM domestic risks have been incrementally changing,” the strategists wrote in an emailed note. “EM FX will find it difficult to attract inflows at current levels of both exchange rates and interest rates.”

Russia Risk

Russian rates and the ruble in particular have drawn concern from JPMorgan, which shifted to market-weight from overweight last week. That’s when a massive buildup of troops on the border with Ukraine started weighing on ruble bonds, known as OFZs.

In 2018, the Treasury Department warned of global financial market turmoil if Russia’s sovereign debt market were sanctioned because of how deeply tied the Russian market is to global indexes. Since then the California Public Employees’ Retirement System, or Calpers, has cut all of its bond holdings in Russia. Foreigners have curbed their share of the total market to just 20% from about 35% last year as the Finance Ministry sold more debt to locals.

In their downgrade for the outlook on Russian bonds, JPMorgan noted the risk that U.S. investors might close long positions on OFZs. In recent debt auctions, the Finance Ministry has had to rely on state-run banks to meet demand after a March 24 sale was canceled due to reduced appetite from foreign buyers.

China Flows

The bank also cut exposure to the Chinese yuan in its model portfolio, saying the near term prospects for the yuan appreciation has dimmed and citing a slowdown in Chinese growth and portfolio flows.

After a brutal selloff that wiped out more than $1.3 trillion in market value, China’s benchmark stock index remain below a 13-year high in early February. The yuan just suffered its worst month in a year in March, while foreign investors lowered their holdings in Chinese sovereign bonds last month for the first time in more than two years.

While a dovish Federal Reserve and EM technicals are potential sources of support, they are unlikely to drive EM currency appreciation, the strategists said. Only the South African rand and the Chilean peso posted modest gains this year.

Emerging-market countries are expected to grow will 5.2% this year, while developed economies will expand 4.9%, according to average estimates on Bloomberg economists. That would mark the smallest growth gap between the two groups since at least 2014, the data show.

“This is resulting in ever fewer candidates we would like to be long in EM currencies, against an environment of rising rates where EM growth will be lagging,” the strategists said.

©2021 Bloomberg L.P.

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