Currency Hedging in Vogue as Emerging-Market Relief Rally Fades

(Bloomberg) -- September’s rally in emerging-market currencies is so fragile that analysts from Morgan Stanley to Societe Generale say it’s time to revisit hedging strategies. Some insurance would have come in handy for bulls this week.

Amid Mideastern political turmoil, currencies snapped their longest winning streak in almost two years this week, erasing nine days of gains and leaving MSCI’s developing-market currency gauge essentially flat for the year. And while the U.S. and China are once again holding trade talks -- diminishing 2019’s most persistent headwind -- optimism can be quickly be undone by a random Twitterstorm.

Now, as central banks around the world follow the Federal Reserve and European Central Bank in cutting rates, analysts say investors should seek places where interest rate differentials are narrowing, potentially lowering the cost of shorting a currency to hedge emerging-market exposure. It’s also important the currency is liquid and has a high and stable correlation to the risks the hedge aims to protect. Brazil, whose central bank just cut rates to a record low and signaled more easing, fits the bill.

“If you want to be long EM, you could be underweight BRL and it would be a good hedge,” said Andres Jaime, a New-York based Latin America strategist at Morgan Stanley. “The Brazilian real is relatively cheap to hedge, it is very liquid, and its correlation with the risk factors relevant to EM is very high.”

Here’s what other analysts have to say:

Brendan McKenna, a currency strategist at Wells Fargo in New York:

• Wells Fargo recommends clients protect their investments by hedging the actual currency to which they are exposed. McKenna said he’s been telling clients with assets denominated in South African rand, Turkish lira, Argentine peso and Mexican peso -- and to a lesser extent the Brazilian real -- to hedge their investments as the currencies are likely to weaken if there’s a sudden downturn in global risk appetite
• “We have been seeing a lot of clients look to put on hedges for their emerging-market exposures and we’ve been encouraging that right now as well,” he said. “The outlook for broader emerging markets is going to be challenging for the next couple of months”

Alejandro Cuadrado, a senior BBVA strategist in New York:

• Recommends hedging Chilean peso exposure as low rates and flat or inverted forwards cheapen the cost of the hedge. Hedging the Mexican peso is much more difficult, he said, given high rates and the fact that long peso positions have remained close to highs for some time
• “The external backdrop of continued trade tensions, political uncertainty, high risk valuations, excessive reliance on aggressively priced central bank easing and the global slowdown are likely to maintain EMFX on the defense and as the main market for potential hedges,” he said

Kiyong Seong, Phoenix Kalen and Marek Drimal, strategists at Societe Generale:

• Said hedged currency investments in most emerging markets should generate better returns than unhedged ones “for the foreseeable future”
• It pays to have currency hedges in Taiwan, Poland and Korea, while it isn’t worth paying the cost of hedging in Indonesia, Mexico, India and Turkey as costs may be too high
• Emerging-market currencies “have weakened on a broad scale, and we expect it to continue to decline, driven by CNY depreciation in particular,” they wrote in a note this month

--With assistance from Davison Santana.

To contact the reporter on this story: Aline Oyamada in Sao Paulo at aoyamada3@bloomberg.net

To contact the editors responsible for this story: Carolina Wilson at cwilson166@bloomberg.net, Alec D.B. McCabe

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