Macro Vignettes is an occasional detour from the usual EMFX Macro notes, for bigger questions that don’t fit neatly into an FX strategy piece.

Subscribe now

Last week I was at J.P. Morgan’s emerging-markets conference in London. I have always liked a good conference. A few faster-twitch PM colleagues over the years have suggested that I have something of a conference fetish.

They have a point. For the curious investor, a decent conference is a feast. Lots of clever people, different subjects, countries and markets, all compressed into a couple of days. J.P. Morgan also laid on some excellent food with an appropriately emerging-markets flavour. Like most people, I appreciate a free lunch.

Somewhere in the middle of all this, I found myself thinking about the machinery producing the insights I was consuming.

I have been an enthusiastic user of AI since the early days of ChatGPT, sometimes trying to force it into parts of my work and personal life where it probably had no business being. Initially it felt rather like having an unusually willing computer-science intern permanently sitting beside me. It could write a macro, help with some Python, explain a statistical method or save an hour on something tedious. Useful, certainly, but it did not make me rethink the way I worked.

The last few upgrades have changed that. I have been able to overhaul models I originally built myself, add things I would previously have lacked either the time or technical ability to construct, and start projects that would have been impractical for one person even a year ago. More importantly, I can now see much more clearly how the different parts of an investment process might eventually fit together around these systems.

A concrete example is my FX work. I have rebuilt a framework I had been running around macro forecasts, carry and valuation. What began as a fairly conventional model is turning into something much broader, incorporating my own BEER and FEER valuation work, tactical price and momentum signals, and a statistical Country Atlas looking at how individual markets have actually behaved as global rates, currencies, commodities and other macro drivers move. Some of it is still under construction, which is partly the point. Several of those additions would previously have disappeared into the mythical folder marked future enhancements, from which perfectly sensible ideas have a habit of never returning.

This is one reason there has been less writing from me recently. There is only so much spare mental bandwidth available. A fair amount of mine has disappeared down increasingly ambitious AI-assisted research rabbit holes.

During a break in the conference I went for a walk around Canary Wharf. I had not spent much time there recently and, on a sunny September day, it looked terrific. Coming from the West End, it almost felt like stepping into another country. Gleaming towers, busy restaurants, new buildings and people everywhere. It bore rather little resemblance to the London presented by Tommy Robinson and some of his admirers across the Atlantic. Broken Britain had apparently taken the afternoon off.

I suspect the best large financial institutions will do extremely well from AI. J.P. Morgan is hardly waiting around to be told that this matters. Even as a user, I have noticed its research search tools becoming dramatically better, and a bank with that much data, capital and quantitative talent is likely to find uses for these systems that I have not thought of.

Financials have had a strong run for plenty of reasons, but I suspect some of the enthusiasm reflects a growing sense of how much operating leverage the better institutions may eventually extract from AI. The question that interests me is what those institutions look like once AI starts changing the production function itself.

The bottleneck

My own use of AI has moved through a fairly obvious progression. First came the discrete tasks. Explain this. Summarise that. Fix this formula. Write this code. As the models improved, the projects became much more ambitious.

I am currently juggling several modelling and market-analysis projects alongside the less optional business of actually following markets. AI can do a remarkable amount of the heavy lifting, but somebody still needs to review the work, steer it, spot when it has wandered off in the wrong direction and decide what happens next, and increasingly that somebody is the scarce resource.

In theory I can have several projects running at once. In practice they compete for my attention. The machines can produce analysis rather faster than I can properly digest it. I can ask one model to build something, another to critique the methodology, feed the useful criticism back into the first process and then inspect what comes out.

When I share the output of a new model with colleagues and somebody asks whether AI built it, I tend to point out that they are looking at version 42 and that I was involved in all 42 versions. AI didn’t build the whole thing while I was out getting a burrito.

At times the binding constraints seem to be my mental bandwidth and how many AI tokens I am prepared to buy. This is already a fairly odd change in the economics of being a portfolio manager. It is also vastly more efficient than the way I worked even a year ago, while some elements of the process already look rudimentary compared with where the capability curve seems to be heading.

Having watched these systems improve, I cannot see why I should indefinitely remain responsible for carrying information between them, commissioning each successive piece of work and checking every intermediate step myself. Today I want to stay heavily involved because the models still need steering and because I remain reluctant to put money behind something merely because a very confident machine tells me it has checked its workings. But the amount of coordination I provide should fall as the models improve.

For now, AI gives an experienced investor extraordinary leverage. Once more of the checking, coordination and iteration can be delegated as well, we are looking at something rather more interesting than a better Bloomberg terminal, which is where the industrialisation analogy starts to bite.

Asset management looks particularly exposed

Almost all our inputs are digital. Prices, company reports, economic releases, broker research, transcripts, positioning, spreadsheets and databases. Most of what happens in between takes place in our heads or on computers. We read, calculate, compare, model, argue, write and decide. Eventually some combination of numbers and judgement becomes an instruction to buy, sell or, quite often, do nothing.

There is almost no physical friction in the chain, and there is also an awkward economic feature. Clients generally do not care how lovingly an investment view was made.

There will probably always be room for artisanal bread and handmade furniture because the method of production is itself part of what the customer values. I struggle to imagine a meaningful market for an artisanal Sharpe ratio.

There is a further problem for asset management. More analysis does not create more alpha. If every serious investor suddenly has access to vastly more cheap, competent analysis, much of the advantage from generic analysis should simply be competed away. The valuable things become whatever remains scarce, including proprietary information, access, execution, capacity and the ability to decide which of an abundance of plausible answers is actually worth putting money behind.

That is also part of the industrialisation analogy. Industrialisation did not merely reorganise production. It dramatically reduced the price of the things being produced. In markets, generic analysis looks increasingly vulnerable to the same economics.

That does not mean there is no future for specialist asset managers. In some cases AI could make them much stronger. A specialist firm may operate in a capacity-constrained market, possess unusual relationships or experience, or work in areas where another few billion dollars of capital would simply destroy the opportunity it was trying to exploit.

A handful of experienced investors may also gain access to research and analytical capabilities that once required a far larger team and, importantly, the AUM needed to pay for it. Being small need no longer mean being analytically under-resourced in quite the way it once did.

At the other extreme, the largest firms can combine the same frontier models with proprietary data, large engineering teams, superior execution infrastructure and enormous amounts of capital. I can imagine both ends doing well, with the more uncomfortable place somewhere in the middle. Lots of expensive cognitive labour, no great proprietary data advantage and no genuinely capacity-constrained niche.

I do not think this reduces neatly to big firms beating small ones. A genuinely specialist six-person firm that uses these systems aggressively may be a much more formidable competitor than a sixty-person firm organised around an older production model.

From AI-assisted firms to AI organisations

For a large bank, the obvious first stage is to give every economist, analyst, salesperson, trader and banker a powerful assistant. That already matters enormously, but it leaves the organisation chart largely intact.

The next stage is more interesting. More of the analytical work can sit inside machine systems that maintain models, follow markets, monitor releases, compare forecasts and check one another’s work. Some of the coordination between those systems can itself be automated. The bank will presumably build versions of this far more sophisticated than anything I can sketch from outside, which is rather the point. At that point it becomes less obvious that the useful unit of intelligence is the individual analyst rather than the organisation around them.

We do not need the banking equivalent of Deep Thought sitting in a basement in Canary Wharf. A large number of highly capable systems that can work continuously, specialise and communicate may be enough to create something resembling collective machine intelligence.

There will still be humans. Some information simply is not sitting in a database. Somebody has spent twenty years speaking to finance ministers or company management teams. Someone was actually in the room. Client relationships matter, institutions require accountability and somebody ultimately owns the risk.

Politics is an especially stubborn boundary. A machine may become exceptionally good at explaining what a political decision would mean for markets without becoming equally good at predicting what a particular politician decides to do tomorrow morning. Sometimes the information does not yet exist because the politician concerned has not made up his own mind. Even enormous amounts of compute struggle with that inconvenience.

The sell side also faces a challenge from the other direction because its clients are acquiring the same technology.

I have only a limited background in single-name equities, for example, but AI has already changed how far I can sensibly venture into them. I can take models and forecasts produced by several banks, interrogate the assumptions, compare them and get much more quickly to where the real disagreement lies. That has allowed me to get considerably further into companies such as SK Hynix than I would previously have attempted on my own.

There is something slightly absurd about using machine intelligence to interpret human forecasts about whether I should invest in a company whose memory chips are helping to run machine intelligence. My personal account over the next six months may establish whether this represents genuine democratisation of expertise or merely proves that a little knowledge remains a dangerous thing.

If the client’s own system can read everything published overnight, compare the assumptions, update its models and identify the two things that actually matter, the 40-page report starts to look like a fairly inefficient communications protocol.

The bank still has enormous advantages. It has proprietary data and market information, execution capability, balance sheet, access to companies and governments, institutional trust and a privileged position inside the financial system, all of which should matter more as generic analysis gets cheaper. Quite a lot of the interaction between institutions may eventually happen machine to machine, with humans becoming involved when there is genuinely something worth discussing.

Industrialising cognition

Previous industrial revolutions did more than put better tools in workers’ hands. Production was reorganised around the machinery. The factory mattered as much as the machine.

That is the part of the AI story I find increasingly interesting. We have spent plenty of time debating whether AI replaces lawyers, accountants, programmers or analysts. The more consequential change comes when organisations start redesigning themselves around the assumption that large amounts of cognitive work can be produced cheaply, continuously and in parallel. At that point the organisation chart becomes an historical document rather than a law of nature.

I have found it useful to think of advanced AI as a new supply of cognitive labour rather than simply another generation of software.

A fairly brutal test follows from that. If you were building the organisation from scratch today, knowing what these systems are likely to be capable of, how much of the existing structure would you recreate? In many cognitive industries, I suspect the honest answer would make the current occupants of the organisation chart uncomfortable.

The professional life

Walking around Canary Wharf, I kept coming back to the professional lives represented by all those towers.

Everyone was doing the normal things professional people do. Going to meetings, having lunch, trying to get promoted and building careers. Presumably they are also buying houses, choosing schools, paying into pensions and making the other long-duration decisions that come with professional life.

All of that is perfectly understandable. We do not know how quickly this transition happens. Models may improve more slowly than expected. Governments may intervene to protect workers or slow deployment. Regulation matters. Institutions move slowly and ordinary life cannot be put on hold while we wait to discover how clever the next model becomes.

Still, quite a large assumption sits underneath the normal professional life. Get educated, enter a profession, accumulate expertise, move up the hierarchy, turn expected future earnings into a mortgage and expect the economic value of that accumulated human expertise broadly to rise with age.

It has been an extraordinarily successful formula. It is slightly destabilising to consider how plausible it now is that the formula itself changes.

Finance is an interesting place to observe this because we spend much of our working lives thinking about disruption elsewhere. We happily model changes in productivity and competitive advantage for other people. It is presumably less enjoyable to put one’s own career into the model.

I imagine plenty of people in Canary Wharf are already having uncomfortable conversations with themselves about what AI means for their role. But markets are absorbing, careers are absorbing and ordinary life is absorbing. There is probably also a healthy psychological immune response to following a line of reasoning that ends by questioning the assumptions behind the mortgage you signed last month.

The institutional response will lag the technology anyway. Firms first give people better tools. Processes then begin to change. Eventually one analyst can cover far more companies, an economist can cover more economies, or work that once required several layers of people is organised in a different way. Headcount tells you about some of that change only after the underlying economics have already moved.

Where does this leave the humans?

For the moment, I am thoroughly enjoying the transition. There are not many occasions in a portfolio manager’s career when investing time in the process itself can produce such obvious gains in capability. The build-it-from-scratch test is nevertheless becoming hard to ignore.

If an investment organisation were being designed from scratch today, with the tools already available and some allowance for where they appear to be heading, it is hard to imagine recreating the labour-intensive analytical structure of the past. Human effort would be concentrated closer to the decisions where actual risk has to be owned, where relationships matter, or where the relevant information never enters the machine cleanly in the first place.

Humans are not disappearing from investment management, but the division of labour is starting to look different, and the sensible organisation to build around it may look different too.

The more time I spend building with these systems, the more I find myself wondering which part of this job will still be the valuable part.

Share

This is not investment research or investment advice. The views expressed are personal.

Subscribe now

The ageing reflex

China’s manufacturing success is creating gravitational forces that are reshaping the development paths available to EM economies. In this note, I’ll unpack what that means.

Earlier in my career, there was a safe reflex toward China. Watch lending data, keep an ear to the ground on policy, and on any sign of an acceleration in China, buy EM assets. We all understood the transmission mechanism well. Chinese growth upswings were driven by property and infrastructure booms, which pulled in commodities, machinery and other capital goods. As a result, much of the emerging world experienced a boost to demand. Time it right, and you had a career.

Some years ago, that relationship weakened. After the property downturn, the way that growth connects to the rest of EM has changed. The new pattern is less supportive, with China sustaining activity more through manufacturing scale, and the adjustment being pushed outward through surplus supply and tougher competition in tradable goods.

This is well reported, but mostly as a developed-market problem. We’re familiar with the arguments about tariffs, ultra-competitive electric vehicles and solar, and how they shape industrial policy in Europe and the United States. As an EM investor I want to discuss what it means for the countries in the middle. Many EM economies do not have the market size, fiscal capacity or policy room to respond effectively.

The harsh truth is that China’s success has changed the opportunity set for others. Manufacturing was the most common route through which earlier Asian economies escaped the middle-income trap. For much of EM, that route now looks increasingly narrow. China’s scale, pricing pressure and supply-chain depth are compressing the space available to EMs that wish to follow that path. The consequences are significant for medium-term growth quality, current account durability, and the country-level dispersion that increasingly drives differentiation in EM local assets and FX.

The old playbook has died. The replacement needs a better mental model.

The gravity well

As a former physicist, the metaphor I’m drawn towards for the new China-EM transmission is a gravity well. In physics, a gravity well is a way of visualising gravitational potential. A sufficiently large mass creates a dip in the field. Where in the past we thought of objects as being “pulled in” by some special force, thanks to Einstein, we now think of them as following the shape of the field. If they do not have enough energy to escape, they remain bound to it, often in orbit. For the metaphor to earn its keep, the terms need to be precise: mass, distance, thrust and escape.

In this context, the mass is China’s industrial ecosystem. The point goes well beyond low wages or marginally cheaper production. The learning curves were climbed years ago, the supplier networks are dense, and the state can keep capacity alive through periods of weak profitability that would shutter plants elsewhere. Any country trying to compete in that environment is up against a whole industrial system. Distance is not mainly geography. It is economic distance. Tariffs create distance. Standards create distance. Rules of origin create distance. Sanctions risk creates distance. Market access creates distance. EU membership is a form of reduced distance to one industrial bloc and increased distance from another. USMCA does something similar.

Thrust is the set of forces a country can apply to change its trajectory. Policy continuity matters. Capital deepening matters. Technology transfer matters. Security cover matters. Most of all, access to a large final-demand market that is not China matters. Without some combination of those, countries can integrate into the system but struggle to alter the terms of that integration. Thrust, in short, is what most EM countries have just enough of to stay in orbit, and not quite enough of to leave it.

A gravity well is not a black hole. I don’t want to provoke the image of countries crossing an event horizon and journeying to economic oblivion. Orbit can work. That is part of the trap. Countries in orbit can still grow, export, industrialise at the margin and at times perform well. However, the danger is shrinking autonomy and capability over time.

A slingshot candidate is a country with privileged access to a large non-Chinese market and enough thrust to move beyond node status. A shielded economy is protected by deep institutional integration into an alternative industrial ecosystem, effectively operating inside a different well. An orbit node is a country that operates inside China-centred supply chains but struggles to ascend the value chain. A debris field country is one showered with cheap goods but whose own industrial ladder never properly catches light.

China is not the only gravitational mass in the system, but it is the fastest growing and the newest force. The US and the EU create their own wells, with their own barriers and internal protections. But any barriers they erect merely redirect the impact of China’s industrial force. Output that is prevented from entering developed markets is pushed elsewhere. This is particularly toxic, as it accentuates the debris-field problem at the EM periphery.

The engine change

The old Chinese growth model used debt expansion to keep domestic activity high, whilst pulling in demand from the rest of the world. This delivered impressive GDP figures but also a level of development sufficient for the social contract. The country was upgraded around its citizens, as they enthusiastically ploughed savings into an appreciating property market. Wealth effects and rising living standards compensated for visible constraints on personal and political freedoms. Property, a cornerstone of the model, broke decisively in 2021, marked by the Evergrande collapse. Nearly five years on it shows only tepid signs of recovery.

Decades of investment have seen China’s transport and energy infrastructure in its major industrial corridors become world class, leaving limited room for incremental productive investment. On the initial lurch lower in real estate, infrastructure investment was well calibrated to provide a temporary bridge, with manufacturing investment also providing support. The striking feature in the latest data is that all three major investment channels are sagging at the same time. GDP has held up in the aggregate, with past investment having built the capacity to deliver on growth targets with net exports picking up the slack. The balance is fragile. As domestic investment loses force, the pressure shifts further towards utilisation and output.

Manufacturing is the engine that’s still firing, and has played a key role in powering China through the property collapse. The issue for the rest of the world is what a powerful industrial system does when domestic demand is too weak to absorb what it can produce. China does not need to keep building the well deeper. The mass is already there. The question is what that capacity is producing, and where it is going.

The mass accumulates

China’s share of world manufactures exports has moved in a fairly narrow range over the past decade. However, since Covid, China’s export machine has looked much more forceful: volumes are up, the manufactured goods surplus is much larger, and imports have been much less impressive. China is pushing harder, and the push is moving into sectors that matter more for EM industrialisation.

Automotive products are the standout case. China’s share of world automotive exports rose from 3.7 per cent in 2015 to 10.3 per cent in 2024, catapulting it into the trophy sector of global manufacturing. Non-auto transport equipment and industrial machinery tell a similar story, with world export share rising from 10.3 to 16.2 per cent and 18.3 to 23.5 per cent respectively. By contrast, sectors where China is already well entrenched have seen share drop off sharply. Most notably electronic data processing, telecommunications equipment and clothing.

The relevant point for EM is compositional. The pressure is strongest in areas that matter more for the next stage of industrial upgrading. In Chinese discussion this dynamic is often described as neijuan, or involution: competition so intense that firms keep cutting costs and running harder even as margins compress. This is why Chinese export pressure now lands in the sectors many EMs hoped to enter.


Exporting the adjustment

China’s merchandise export volumes rose 73% between 2015 and 2025, while export unit values fell 4% over the same period. More quantity is leaving the system, at lower prices than a decade earlier. The 2022 spike in unit values was commodity and freight. Once that faded, the structural signal reasserted itself.

Local governments, in addition to having output targets, collect VAT at the point of production. This means they are given powerful incentives to keep factories operating. Capacity that would shrink more quickly in a normal market setting can remain in operation for longer. Cheap financing and that “famously competitive” exchange rate reinforce the same outcome. The result is a system in which weak domestic demand does not lead cleanly to lower output. It leads more often to output being pushed outward.

It’s worth going deeper into the potency of neijuan, or involution here. China has produced a system where competition is so intense that firms are forced into a near-continuous cycle of cost cutting, process improvement, automation and product iteration. Firms that survive inside that system emerge faster, leaner and more adaptive than rivals operating in calmer markets. They learn to redesign quickly, source more efficiently, compress lead times and strip cost out of production with unusual speed. The result is an industrial base with a kind of brutal potency: a domestic arena so competitive that surviving it becomes, in effect, a training ground for global dominance.

The state has initiated the process and fuelled it with subsidies. In a normal market, competition this brutal would eventually clear the weaker players and allow margins to recover. China’s system and its incentives make this cleansing difficult and slow. As a result, excess capacity stays, and the pressure has nowhere to go but out.

One Chinese sensor manufacturer saw its unit price fall from around $30 to under $2 in five years. The rate at which its competitors improved must have left the owners’ heads spinning.

The micro version of the chart plays out among Chinese producers in sectors tied to the EV supply chain who have seen selling prices collapse over a few years, as competitive conditions left them little choice. Quantities keep rising. Margins get squeezed.

For EMs, competing on cost alone is an empty pursuit, with the cost floor moving down. The same process has produced some real gains for some trading partners. Cheaper solar and battery technology benefits energy importers and electrification programmes. The distribution matters. Some countries get cheaper inputs. Others get their industrial margins crushed.

My overriding message is that the sectors under the greatest pressure are the very sectors middle-income economies would normally target in order to become richer. Autos, machinery, batteries, electrical equipment and the broader tradables ecosystem around them are the core route to higher income status. China has successfully industrialised on a scale that will outmuscle most attempts by others to follow suit.

The old China model absorbed external demand and created space around it. The new one sustains output at home and pushes pressure abroad. For countries still hoping to use manufacturing as the main route through the middle-income trap, the reality is beyond disheartening.

Who gets hit

Chinese manufactured goods are not landing evenly across EM. The first thing the data does is sort countries into three broad camps. Some countries are receiving Chinese manufactures as the other side of a commodity trade. Saudi Arabia and Chile sit high on the raw penetration measure, but this is not quite the same as industrial displacement: commodities go out, manufactured goods come back. That still matters for terms of trade, but it is not the same problem as a domestic manufacturing ladder being kicked away.

The more relevant pressure points are the countries where Chinese penetration is rising in sectors where local industrialisation would normally need room to deepen. Pakistan, South Africa, Peru and Egypt sit closer to that debris-field pattern. Consumers quite like cheap goods, as it turns out. The issue is scale and price: whether Chinese supply is arriving at levels that make local alternatives harder to form.

A third group looks different again. Vietnam, Indonesia, Thailand and Malaysia show high or rising Chinese penetration alongside export success. That is the orbit-node problem. Integration into Chinese-centred supply chains can support growth, jobs and exports. It can also deepen upstream dependence. From a distance, both can look like industrial success. The wiring underneath matters.

The second view adds the missing dimension: where countries already sit. A modest recent increase can still leave a country deeply embedded, while a large increase from a low base may mean a country is only now being pulled in. On that basis, Pakistan, Vietnam and Indonesia look among the most exposed. Mexico remains unusually insulated. CEE sits lower and flatter than most of the EM universe, with the EU pull visible in the data. India sitting alone tells us a lot. This is the only country large enough to generate enough of its own gravity to stand away from the others.

Rising Chinese penetration can mean cheap finished goods crowding out local production, Chinese intermediate inputs feeding export growth, or commodity exporters recycling their China revenues into imported manufactures. Those are not the same economic story.

What neither chart can tell us on its own is whether rising Chinese penetration is crowding out capability or helping to build it through supply-chain integration. That is the line between orbit and escape.

Orbit or escape

The next test is whether Chinese inputs are helping countries build capability or merely passing through them. Importing from a more advanced industrial base has often been part of the industrialisation process. Countries start by assembling other people’s components, then try to climb into local content, intermediate production, tooling, design and eventually higher-value exports. The question is whether the Chinese supply chain still works that way for latecomers, or whether it now holds many of them closer to the lower rungs.

The chart should be read simply. Moving right means a larger increase in Chinese machinery and transport inputs. Moving up means a larger gain in world intermediate export share in electronics and vehicles. Inputs in, capability out. That is the test.

The pattern is not especially comforting. Indonesia is the cleanest orbit-trap case: more Chinese machinery and transport content coming in, little intermediate export capability coming out. This is different from the debris-field problem, where Chinese goods arrive at scale and crowd out local formation. In the orbit trap, a country is inside the chain but not climbing it.

Vietnam is the awkward case, which makes it the interesting one. Its export gains are real. Some of this may be tariff dodging or transhipment. It would be odd if none of it were. But the gains are not just paper flows. The better question is where the value added sits. Intermediate export share has risen strongly. But those gains have come alongside deeper dependence on Chinese upstream inputs. China’s own move up the ladder creates room for Vietnam to do some of what China used to do. To put it more crudely, how many more rungs can it climb before hitting its head on something hard?

Mexico sits closer to the other end of the field. Chinese input dependence has risen only modestly, while intermediate vehicle export share has increased materially. That looks much more like a slingshot: privileged access to US demand, rules of origin that force local content, and enough industrial base to make the opportunity real. Poland points in a similar direction through European integration rather than USMCA. These cases are rare because the conditions are specific. Access alone is not enough. The system has to force capability to accumulate locally.

Mexico is also a useful warning against getting too excited. Long-time EM investors have seen this film before. Mexico has had a better structural hand than most peers for decades, and yet per-capita income performance has still disappointed. A slingshot position creates the possibility of escape. It does not guarantee that the country uses it well.

Brazil is the warning from the other side. It has scale, a large domestic market and a plausible claim to industrial ambition. Yet in this data it shows higher Chinese input dependence with weak intermediate export performance. Scale helps. It does not create escape velocity by itself. The country of tomorrow can remain the country of tomorrow for a long time; China is not the only reason, but it does not make the climb easier.

The rest of the chart fills in the pattern without needing a country-by-country autopsy. The Czech Republic looks more capable than countries with similar Chinese input penetration, consistent with institutional embedding in European supply chains. Hungary and Romania sit in the more insulated part of the field. One caveat is that gross trade data may flatter the CEE story if more Chinese value added is already sitting inside European supply chains. That is a follow-up rabbit hole, not one to disappear down here. The commodity cases sit near zero on intermediate export gain, which is consistent with the earlier point: this is not their main channel.

Orbit is not a waiting room. It is a business model. Countries and firms adapt around the Chinese ecosystem. They source upstream from China, specialise in assembly or downstream functions, and try to hold margin where they can. That can be rational, profitable and politically attractive for a long time. The question is whether it builds autonomy, or whether it simply teaches the economy to live inside someone else’s supply chain. Politics may not always tolerate this either. In democracies, manufacturing jobs, trade deficits, national champions and foreign ownership can become live issues quickly. Orbit can work as a business model and still become an ugly political story.

India and Malaysia are the two important gaps in the chart. India matters because it is the major large-country attempt at an alternative manufacturing platform. Malaysia matters because it is probably one of the more sophisticated orbit-node cases, with semiconductor strength sitting alongside deep regional input dependence. The data isn’t clean enough to place them with confidence.

This is the distinction the data makes visible. Some countries are taking in more Chinese inputs without building much intermediate capability. Others are using their position to build something more durable. The trajectories are not the same, and the gap between them is likely to widen.

Why escape is hard

The uncomfortable part is that many EM governments understand the risk. They know that deeper reliance on Chinese inputs and capital goods can weaken the long-term industrial ladder. They often deepen that reliance anyway. The reason is not mysterious. Chinese equipment, intermediate goods and financing arrive quickly and cheaply. The alternative requires sustained industrial policy, patient capital, institutional competence and technology access over many years. Most countries do not have a political system capable of seeing through multiple coherent five-year plans.

For a domestic electorate, the near-term gains from integration are visible: lower costs, faster project delivery, export jobs, cheaper infrastructure. The long-term cost is harder to see. A domestic supplier that never forms does not complain. A capability that never accumulates does not show up in the data as a missing factory. The loss is real, but it is politically quiet. By the time a nation is able to look back on disappointing progress the leaders that took the decisions are long gone.

The US is the obvious escape route in theory. It has the market, the technology base, the financial system and the strategic motive to provide counter-gravity at scale. Increasingly the problem is reliability. Tariff policy moves around, allies get treated transactionally, and support for external commitments has become less predictable. That said, the US is not simply unreliable noise. Anti-China policy now runs deeper than Trump. If US restrictions stay focused on China rather than spreading across all surplus economies, the US orbit can still look attractive for countries able to qualify. The question is whether America uses market access as a strategic asset, or waves it around like a broken bottle. For countries trying to make multi-decade industrial decisions, that matters. A slingshot needs a sponsor that stays in place long enough for firms to build around it.

Europe is the other serious alternative. For much of EM, the EU is the only non-Chinese demand bloc large and rich enough to matter. That is why EU-Mercosur and EU-India are important beyond the usual trade-volume arithmetic. They shape whether large EMs can credibly build around an alternative market. Europe sees the China problem clearly enough. Its difficulty is speed, internal politics and the instinct to protect domestic producers first. Quite European, in other words: diagnose the problem, schedule a committee, then argue about the commas.

Developed-market protection also has an awkward side effect. Barriers in the US and Europe do not make Chinese industrial pressure disappear. They redirect it. Some flows are routed through connector economies. Some are pushed towards less-protected markets. Some Chinese value added moves one layer upstream and becomes harder to see and harder to attribute. The shield around the core can increase the pressure on the periphery.

This choice is becoming harder to blur. In the old trading system, countries could mix Chinese inputs, US demand and European standards without thinking too hard about the contradictions. Tariffs, rules of origin, export controls and security screening are making that harder. The ambiguity is getting more expensive.

That helps explain the BRICS-style hedging. Many EMs are not choosing China because they have decided the Chinese model is a warm bath of strategic benevolence. They are choosing optionality. The short-term financial and infrastructure benefits are concrete. The long-term industrial cost is diffuse, contestable and easy to defer.

Escape routes exist, but they are scarce. You need access to a large market, enough domestic capability to use it, policy that survives the next election, and a sponsor that does not decide to rewrite the bargain halfway through. That is a high bar. Most EMs will not clear it. The current pattern is therefore likely to persist. A few countries have enough thrust to break away. Most do not.

Tide or gravity

For a long period, stronger China meant stronger EM because the impulse ran through property, infrastructure and imported goods. That relationship has broken clearly enough that the old playbook is now a liability.

The commodity channel still exists. China stimulus, credit impulse and activity data still move EM assets. But a China impulse that leans into manufacturing capacity is not the same thing as one that leans into property and infrastructure. It may help some commodity exporters while tightening the noose around EM manufacturers and assembly economies. For some countries those forces offset. For others, one dominates. Models calibrated on pre-2021 data will not capture that distinction cleanly.

If this reading is right, the conclusion is harsher than “more EM dispersion”. It means lower structural expectations for a large group of countries still trying to industrialise through tradables. Some will benefit from cheaper Chinese capital goods, lower technology costs and supply-chain integration. Some will build around a genuine alternative market. Many will take in more Chinese inputs and finished goods without building much autonomous capability in return. This is the weaker medium-term development story that I think many are missing.

Generic industrial catch-up stories in exposed EMs deserve much more scepticism. The more useful question is what kind of China linkage a country has. Commodity EM and industrial EM need to be separated more carefully. Orbit-node success needs to be read through the value chain, not through gross export numbers alone. Strong exports can still hide deeper upstream dependence and a more fragile position than the headline suggests.

The slingshot and shielded cases are real, but they are scarce and contingent. Mexico has USMCA, but also a long record of turning an excellent strategic hand into disappointing income growth. Poland has European industrial integration, but also exposure to Germany’s ability to remain an industrial engine. These are better positions than most, and deserve more attention than most, but they are not automatic wins.

The practical conclusion is to lower the prior on broad EM industrial convergence where Chinese penetration is rising and little is being built locally. Raise the bar for countries claiming to be alternate manufacturing platforms. Treat shielded and slingshot cases as exceptions worth paying for.

China still matters for EM. The difference is that it now helps decide which countries can still industrialise, and which are left buying the goods they once hoped to make. It is no longer a tide. It is gravity.

Share

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Subscribe now

Just as macro traders had settled into the latest cottage industry of becoming temporary experts on AI, hyperscaler capex and the vulnerability of EM services exporters, a much older threat reasserted itself. We pivoted abruptly from the socialisation of cognitive labour to the price of oil, the security of shipping lanes and the familiar tyranny of energy dependence.

In the early phase of a shock like this, you can’t get the fundamental playbook out too early. It’s all about positioning. Long EM. Long gold. Short dollar. They made sense, but were crowded. We’re rarely fast and ruthless enough with our favourite trades, and this is another lesson in that.

After the initial moves, we began to see the usual higher oil terms of trade dispersion. With what now looks on the charts to be a significant lag, rates markets began to price renewed inflation pressure and tighter policy constraints. Unwinds and old habits produced a dollar bid, but I think it is less convincing on fundamentals. In amongst the pain, the reality is that the issuer of the reserve currency is behaving less like the steward of a system and more like the biggest source of risk within it.

At the centre of this mess is an American president who appears too vain, too impatient and too cognitively lazy to absorb even a moderately complex chain of consequences, yet retains enormous power to unleash one. He ignored the most obvious second-order risks around Hormuz, energy infrastructure and oil, then seemed to expect the allies he has spent months insulting to help contain the fallout. On Liberation Day, the world discovered that the supposed guarantor of the system was being steered by an orange pensioner who neither grasps the facts nor cares much for the discipline of mastering them. He has since graduated from terrorising global trade to waging an illegal war and threatening the global energy system, apparently no more troubled by the collateral damage to poorer nations than he was by the human costs of the USAID rug-pull.

America still retains the advantages of scale, geography, energy and incumbency. Those do not disappear because the executive is erratic. But once the first-order effects fade, the dollar will likely take another reputational hit. The United States still has the power of a hegemon, but increasingly lacks the seriousness of one.

This note is a post-mortem on the initial reaction and an attempt to separate fragility from positioning. I look at how EMFX actually behaved through the sell-off, where the terms of trade shock mattered and where it did not, why another inflation pulse is awkward for an EM complex that is no longer broadly cheap, and which trades may make sense on any normalisation. I then turn to two case studies: Egypt versus Turkey as competing carry expressions, and Hungary as a potential political asymmetry. There is every chance that some of these ideas hit a tethered mine in the weeks ahead, but it still seems worth taking stock.

Positioning first, then some fundamental follow through

The initial move was mostly a standard oil and de-risking shock. Importers sold off, the dollar caught a bid, and liquid EM proxies were hit first. In several cases, most of the damage was done in the first three days.

That front-loaded pattern is useful. BRL is the clearest example: a large early move, but limited extension afterwards. KRW and MXN fit the same broad category. These look more like fast pricing of the obvious, helped by liquidity and positioning, than a slow discovery of deeper local problems.

The more interesting cases are the ones where the move kept extending after the initial panic. THB stands out. HUF does too. There, the market appears to have moved beyond generic de-risking and started to price something more specific.

Comparing realised sell-off with pre-shock implied volatility gives a rough sense of what was already in the price. ZAR and CLP sold off hard, but not in a way that looks wildly inconsistent with the vol already embedded. HUF looks more notable on this basis. COP came into the year flagged as expensive with election risk, and therefore unlikely to be a major long in most macro books. More managed names like CNH and INR look calmer, though that says as much about policy management as it does about underlying strength.

Three broad buckets emerge. Front-loaded washouts where the market hit liquid risk quickly. Names where the commodity shock was painful but not especially surprising. And currencies where the follow-through was larger and the market appears to have repriced a more local problem. Brazil looks closer to the first category. Thailand and Hungary look closer to the third. In Hungary’s case, FX sold off early, but the more telling move came later as local rates got hit. Early-year bond buying in anticipation of a positive election outcome will have been unwound with a lag, giving a second wind to the HUF selloff.

Commodity shock to an established terms of trade trend

The chart below shows the recent shock against the prior twelve month backdrop. The starting point matters as much as the move itself.

Some countries had been riding a significant positive terms of trade shock for the past year. The oil shock dilutes the highly positive trajectory for Chile, while Brazil and Colombia got tailwinds.

Korea and India had already seen a negative twelve month terms of trade move before the conflict began, and the recent shock adds to it. For Korea, the valuation argument and the chip cycle catalyst were working to offset its negative commodity backdrop. India had no such tailwinds going in, and now it’s only the central bank keeping the beta low.

Thailand is also negative on both time horizons, and gets an extra black mark from tourism exposure.

South Africa gets hit by the oil move, but also the speculative precious metal unwind. This gives it a worse looking outcome than we might have expected on day one.

The broad point is that this shock hit an EM complex with trending and divergent terms of trade dynamics. For several countries, the recent move is compounding a problem that was already building. That distinction matters when you come to look at where the valuation cushion actually exists.

USD: the smile returns, briefly

In my January note, I laid out a four-pillar framework for the dollar: macro pricing inputs, risk regime and positioning, credibility and politics, and external financing. It is worth keeping that map close for what follows, because this episode has moved more than one lever at once.

The relative rates divergence that followed Liberation Day has been gradually reasserting itself since. The tariff shock was the period where pillar three, the governance discount, got embedded in the price. The dollar underperformed its rates signal because the shock was domestic. People drew the right conclusion and got short.

The Iran shock has temporarily changed that. Safe haven demand, oil terms of trade support and relative insulation from a shock that originated outside the US have all pushed the dollar beyond what relative rates alone would justify. The USD smile logic is back, which is something we had not seen work cleanly for a while.

The tactical dollar bid has a fundamental underpinning here too. If you were designing a developed economy to weather an oil shock originating in the Middle East, you would design something close to what the US currently looks like. It is a large net energy producer and it has no meaningful shipping lane exposure in the Gulf. The US equity market has been losing its structural bid from foreign investors, but that process does not accelerate on an oil shock alone. It needs recession risk to really move, and that is not the base case yet. The relative story is genuine, and the dollar rally reflects that.

The question is how much further it runs from here. The soft USD momentum that built post-Liberation Day left a lot of people selectively short, and a geopolitical shock is a fairly efficient way to flush that out. Some of this move is that, rather than a genuine reappraisal. The governance questions that were sitting in the price before the conflict have not been answered. They have just been briefly drowned out. The man running the world’s reserve currency is the same man who triggered the energy shock in the first place. That is not a normal risk regime. When the noise settles, those questions will still be there, and pillar three will matter again. The hegemon lacks discipline, and looks hostage to one man in a way not seen in modern times.

EMFX is not cheap enough for another inflation pulse

I made this argument in January and it bears repeating, because the oil shock has made it more pressing. EMFX is no longer broadly cheap in the way spot charts tempt people to believe. Much of the nominal weakness people remember from the past few years has already been offset by inflation differentials. Currencies that still look optically low in spot are often much less cheap once you look at the real effective exchange rate, and an oil shock adds another layer to that problem for importers. A fresh inflation pulse on top of valuations that were already less forgiving than they looked means the cushion investors might assume is there after a sell-off is smaller than it appears.

The carry and value chart below is the right place to start. The good quadrant is obvious: cheap currencies with carry.

Reading that chart after an oil shock, the first question is which markets still offer a credible real return once you factor in what the energy pulse does to the inflation path. That is what the ex-ante real rates chart adds. These levels will be flattered by the failure of economists to update their forecasts on a timely basis, worth bearing that in mind, but for now it's all we've got.

Brazil is the clearest case where both charts point the same way. It screens cheap on carry and value and sits at the top of the real rates chart with ex-ante real rates approaching 10% by 2027. The recent sell-off looks more like a positioning event than a genuine loss of the medium-term story. The fiscal concerns are real and worth monitoring, but at current valuations and with that real rate buffer, the burden of proof sits firmly on the other side.

Korea remains an interesting relative long. The current account is healthy, the REER is cheap, and there are plausible flow catalysts later in the year, including potential WGBI inclusion. Supply disruption and shipping uncertainty tighten semiconductor availability and will inflate prices further. Firming chip prices flow directly into the current account, and that effect does not require a demand recovery to show up. Korea’s BoP advantage will assert itself as soon as conditions stabilise.

CLP is a different kind of case. The frustration with Chile last year was that the copper story translates slowly into currency gains, partly for reasons I laid out in January around income balance leakage and foreign ownership of the mines. But the quality of the demand driver has improved. China’s property cycle was an unreliable engine for copper. The AI infrastructure buildout is more durable, and the capex commitments behind it are not going away because of one geopolitical shock. On the real rates chart Chile sits in the middle of the pack, not exceptional but not problematic either. Layered on top of the copper story is a reformist government whose policy direction the market had begun to price before the conflict interrupted. That re-rating has been paused rather than cancelled, and when calm returns both threads should reassert themselves.

India looks more vulnerable on multiple fronts and the carry is not sufficient compensation in this higher vol environment. The BoP exposure to this conflict includes oil imports, LNG, export receipts from the Gulf region, remittances from the large Indian diaspora in the Middle East which are a meaningful current account support in normal times, and a potential reduction in FDI. The RBI’s management of the exchange rate means we get an artificially easy exit on INR longs or a managed entry point on shorts.

Thailand barely registers positively on either chart. Low carry, not cheap on REER relative to its own history, and facing an awkward imported inflation problem with limited policy room to absorb it cleanly. The untimely removal of fuel subsidies acts as a local force multiplier. Thailand’s BoP is usually boosted by tourism, and a prolonged conflict with elevated jet fuel prices and heightened travel risk aversion is not a benign backdrop for inbound flows. With the carry working against you and the REER offering no cushion, THB looks less like something to avoid and more like a relative short against something like KRW.

The broad point is the same one I made in January but with more urgency behind it now. Valuations aren’t helping many longs, and will be eroded by another inflation pulse. The burden of proof for EM longs beyond their short term beta to de-escalation should be high.

Egypt versus Turkey: divergent management of the two favourite frontier carry trades

Both countries lose on an oil shock. Egypt is additionally more exposed to food inflation, given its reliance on imported wheat and the political sensitivity of bread prices. Two losers with different adjustment styles.

Turkey chose to defend the path more aggressively. That’s not surprising as it’s the linchpin of their disinflation efforts. A major investment bank estimates that between 27 February and 23 March, the CBRT’s net foreign assets excluding swaps fell from around $70 billion to $20 billion, with roughly $34 billion reflecting FX intervention to support the lira and the remainder largely gold price moves. Gross reserves including gold were still around $161 billion as of 23 March, so this is not a story of immediate exhaustion. But the usable liquid FX stock is much smaller than the gross number suggests, something closer to $25.5 billion once you strip out gold, swaps and IMF SDRs. Recent large gold sales reinforce that picture.

Egypt is harder to read on a timely basis. The adjustment is filtered through state banks, Gulf funding and the wider sovereign financing apparatus. What is clear is that Egypt entered the episode with stronger buffers than in past stress events. Net international reserves were $52.75 billion at end-February, net foreign assets had risen to a record $29.5 billion in January, and the IMF completed reviews in late February that unlocked around $2.3 billion.

That matters for the trade. Turkey still screens as the cleaner vol-adjusted carry story. One-year implied gross carry is around 40% and expected net yield around 20% if the path is maintained. Egypt’s NDF curve offers an outright yield closer to Turkey’s expected net yield. If markets normalise, initial TRY gains would come from compression in the forwards. In EGP, there is also room for some yield compression, but also for a reversal of part of the recent 10% spot depreciation. By allowing more volatility and a spot adjustment, Egypt has changed the calculus for existing and future positioning, leading to lower outflows and more near term appeal.

Valuation leans the same way. Turkey still looks rich enough that the burden of proof is higher. Between the two, I prefer EGP.

Hungary: a political trade, briefly interrupted by oil

Hungary is one of the few places in EM where the political catalyst is tangible enough to matter outside of this current mess. The 12 April parliamentary election is widely seen as the most consequential in years. Péter Magyar’s Tisza party offers a plausible improvement in Hungary’s relationship with Brussels, with knock-on effects for EU funding, sovereign risk premia and the HUF.

Polls point to a close contest once you factor in Hungary’s mixed electoral system with a constituency map that favours the incumbent. Tisza will need to win the popular vote by 5-10% to take power. The balance of polls suggests they have a better than even chance as things stand.

Before the Middle East shock, Hungary had become a fairly consensual trade. The view was that an Orban win would see a contained reaction, with some suggesting a fresh term may still force some normalisations with the EU from both sides. Unfortunately, Iran smashed up well reasoned positions, but that de-levering is part of what makes Hungary more interesting again.

The NBH’s March communication matters here. After cutting the base rate to 6.25% in February, it held in March and pointed explicitly to the Iran conflict, higher energy prices and renewed global inflation risks. It also stressed FX stability as crucial for anchoring inflation expectations and reiterated its commitment to positive real rates. If the shock threatens to feed inflation through energy and the currency, the central bank’s first instinct is to preserve the buffer, not to keep cutting.

The election trade cannot become crowded again given the proximity, while the upside remains meaningful. CEE offers little elsewhere, with expensive energy-exposed currencies across the board. Hungary stands out as the most interesting long.

The global saboteur

My earlier notes argued that Trump had become a saboteur of the United States. He has since found a way to expand the franchise. He has moved from vandalising trade relationships and institutional credibility to threatening the global energy complex itself, with the predictable consequences landing furthest from Washington. Tariffs were at least on the tin. This was not.

That matters for the dollar. In the first phase of a shock like this, the USD can still rally on oil, fear and relative insulation. If we are lucky enough to move into something calmer, I would be inclined to drop the USD like a hot piece of Trump’s Beautiful Clean Coal. The market has a habit of eventually pricing the defects of the executive, not just the immediate mechanics of whatever crisis he has generated.

The United States still has the power of a hegemon. Energy production, deep markets, reserve-currency incumbency. None of that is gone. But the man at the centre of the system is actively degrading the franchise behind it, and that is not the foundation for an extended dollar bull story. We’re the wrong side of the midterms for one of those.

Signing off

Thank you for reading. Feedback is always welcome, and so are disagreements.

These notes exist partly to keep the thinking sharp between the noise of daily markets, and partly to stay connected with people worth staying connected with. If that is you, feel free to reach out.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Leave a comment

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

11 Jan 2026

Subscribe now

As macro risk-takers looked ahead to the usual new-year grind, with P&Ls reset to zero (or worse), the leader of the free world was holding court at Mar-a-Lago. Tariff effects were fading into the rear-view mirror and asset prices were still climbing, yet a fresh assault on the rules-based international order was already underway.

Perhaps Maduro hoped 2026 might pass calmly and deliver a dilution of Trump’s political power. With a midterm defeat looking plausible, and a messy scramble for succession likely to follow, the danger might pass. For the Venezuelan leader, it is too late, but this still seems like the central plan for much of the political and business world: placate now, renegotiate later. Take the meeting, sign the vague memorandum, offer the headline concession, and assume the calendar eventually delivers a more conventional White House. That assumption has underwritten the calm market reactions to norm-busting that we’ve enjoyed of late.

Venezuela is the reminder that not all shocks are tariff-shaped. Some genies don’t slip so easily back into the bottle. So one key question we’ll keep asking in 2026 is: will we be able to safely run down the clock on Trump, or will he break things that cannot be easily put back together?

My base case, like most people’s, is that we can muddle through, collect carry selectively, and hope to catch any major turns early. For macro hedge funds, the pivot points in 2025 had enough follow-through to be tradable. There is a serious chance that Trump provokes another set of moves like those seen after Liberation Day. The catalyst could be geopolitical or domestic. In Emerging Markets we often watch polls hoping a volatile incumbent won’t fall far enough behind to inspire them to do something rash. Maybe that’s the model for the US this year.

As usual, self-soothing market participants will ignore political risk until it crosses a threshold. If it does, April 2025 becomes the playbook again: foreign capital owners do the inconvenient thing and hedge an outsized US exposure. EM assets survived that process well in 2025, helped by healthier starting points on positioning and valuation. Those starting points are less favourable now.

2025’s lesson: equities and local rates paid better than FX

Although I write about EMFX, I’ve always traded EM macro across multiple asset classes, as most do. Let’s take a multi-asset perspective and look back briefly at 2025. In most countries, the best risk-adjusted returns were in equities or local rates, not FX. You could have had the macro right, but if you chose FX you underperformed the opportunity. FX, more often than not last year, was the thing that added volatility without improving the outcome.

The above Sharpe ratio chart can be read as a scoreboard. It tells you where markets paid you for taking risk last year, and that in many countries, FX was mostly just an overlay.

LatAm FX carry did its job. The equity piece didn’t add much. In Mexico and Brazil you largely compressed the risk premium. Asia was more nuanced. Some currencies performed on flows, others did little despite a strong equity story. The USD downtrend was a tailwind, but even so, you were better off in most cases owning the local equity story than FX. Turkey was a clear exception where the FX gains were the by-product of an explicit policy to deliver positive real returns to locals holding lira.

Multi-asset EM; FX is rarely the first love

There’s a reality here that FX people (myself included) learn slowly. I love FX because of the liquidity, visibility and the ability to express path-dependent views using options. However, most investors typically buy equity stories and rates stories. FX is the hedge, the overlay, or the risk they tolerate while owning the underlying asset. That matters for 2026 because the ex-ante setup still looks more interesting in equities and local rates than it does in broad EMFX.

On equities, valuations remain relatively compelling in much of EM. The forward P/E chart above shows many countries still below their 15-year average P/E, while the US and Japan sit near the top of their history.

In local rates, there are still several markets with both significant potential for easing over the medium term, along with term premia to harvest. If the global backdrop is benign and US rates volatility behaves, we should expect decent unhedged or partially hedged fixed income inflows to EM.

Those equity and bond flows can be a driver of FX, even where currencies have become expensive.

Macro backdrop

In early 2026, US growth should recover from the shutdown and the after-effects of tariff uncertainty. Inflation is drifting lower ex-tariff effects, but will probably stay sticky enough that policy-making remains a difficult balancing act. The best historical model might be the mid-1980s and mid-1990s mid-cycle adjustments. The current cycle benefits from aggressive fiscal transfers and QE during the pandemic, which has left household and corporate balance sheets much cleaner than they would otherwise have been.

The macro tails to this current state of Goldilocks continue to be a labour market-led US recession on one side, and the risk of rebuilding inflation pressures on the other.

In recent years I’ve talked about the “dragon-greenback squeeze”: EM asset prices caught between weak demand from China and a structurally strong USD. EM was in a long bear market prior to 2025, offering only periodic windows for carry to perform. The post-Liberation Day USD weakness released us from the squeeze. The USD softened, China growth held steady, and EM assets had room to rally.

China: from tonic to gravity well

The impact of Chinese growth on EM is also changing, however. In several past EM bull runs, China growth, driven by property and infrastructure, delivered a demand boost to the rest of the world, including EMs. Post property market collapse, and with its infrastructure at a mature stage, China is running a different kind of imbalanced model. The past model was an intertemporal transfer machine that pulled commodities and capex into the system. In the current one, it runs its industrial base hot and exports the adjustment. The rest of the world is being asked, implicitly, to accept China’s excess capacity as its disinflation engine, and to keep trade barriers politely low while it happens.

For EMs, this matters because China acts like a manufacturing gravity well. It pulls tradable-goods value-add into one system at such scale that latecomers struggle to build the learning curves, supplier ecosystems, and export market share that earlier winners used to climb the ladder. It has gone from a source of demand to a crusher of laggards. That’s not a story that’s going to dominate the market from week to week, but it is another headwind to keep in mind for EM equity, rates, and long-run growth. DMs may find a way to resist the gravity well and protect their manufacturing industries, but this is a steeper challenge for EMs, especially when the US is proving such an unreliable ally.

USD Framework

From the dragon, back to the greenback. Conviction on the USD was long and wrong at this time last year, then short and right not long after. Now we seem to have settled back into something more nuanced, so let me share what I think is a workable map of what actually matters in this regime.

Pillar A: Macro pricing inputs (the day-to-day driver)

Rates complex: still the primary driver most of the time. The USD has largely re-coupled to relative rates, which keeps the focus on US data, Fed (Federal Reserve) rhetoric, and the appointments pipeline, including the Chair. Yes, the battle of the Kevins.

Labour market: today, the highest delta to the Fed path is the jobs data. Non-Farm Payrolls should remain the top volatility event for the USD.

Relative cycle: US versus rest-of-world growth differentials and their direction. This overlaps with rates, but it is not fully captured by rates. This is where US “exceptionalism” lives through productivity outperformance. It is also where any meaningful European or Chinese fiscal push would bite.

Pillar B: Risk regime and positioning

When the macro story is ambiguous, the USD can end up trading off risk. Low volatility and risk-on typically encourages marginal capital to look outside the US, which can lean USD-negative even if the US is doing fine. The exception is when the shock is US-centric. “Liberation Day” was that kind of episode: risk-off, but USD also got sold because the stress was made in America.

A similar pattern could repeat if the catalyst is a US-centric story. A proper tech de-rating or an AI bubble unwind is one version of that risk. The AI investment boom is now a key variable for the USD.

On positioning, indicators suggest a clear short USD, but less extreme than last summer. I’m sceptical, mainly due to the lack of follow-through on USD rallies.

Pillar C: Credibility and politics (tails, not levels)

This one is inherently fuzzy, but it is where the Trump factor lives: fiscal credibility, institutional trust, and the willingness of global capital to continue to hold an outsized US allocation. It will probably matter more as the US rates advantage over Europe and much of Asia erodes.

Pillar D: External financing (slow-burn vulnerability)

The twin deficits rarely make it into the conversation, but they are the structural soft spot. The current account deficit is expected to be around 3.4% this year, which is wider than long-run norms.

EMFX is not cheap: the REER reality

One of the more awkward truths after 2025 is that EMFX is no longer cheap in aggregate. Spot charts tempt you into thinking it is. Yes, EM had a rough few years, the USD had a strong run, therefore EMFX must be discounted, but the numbers don’t lie.

Excuse the reminder, but REER (real effective exchange rate) is nominal FX adjusted for inflation differentials versus trading partners. If a country runs hotter inflation than the rest of the world and the currency does not fall enough to offset it, the currency strengthens in real terms. It gets more expensive, even if it never “rallies” in a way that looks dramatic in nominal space.

Post-pandemic, plenty of EMs ran meaningfully higher inflation than DMs, and for longer. Some of that was policy choice, some food and energy, some currency pass-through. In some places high policy rates, commodity windfalls, reserve usage and controls kept nominal FX more supported than the inflation differentials would suggest. Mexico is a perfect case in point.

There are some elements that lean against the “expensive EM” story. We know terms of trade differentials belong in any true valuation comparison, and 2025 saw some significant moves there.

Country rundown

I don’t usually do this, but it has been a long time since my last note, so I thought it best to plant a few flags.

CEEMEA: expensive can get more expensive

CEEMEA has mostly been about vol-adjusted carry with little in the way of macro shocks. I’ve underappreciated how lucrative that could be in CE3. The additional challenge now is that there are no cheap currencies left in CEEMEA.

Turkey (TRY) remained business as usual: high carry, heavy management, periodic political drama. The judicial episode was a useful stress test for the policy reaction function, and the carry less depreciation profile stayed intact. 2026 will likely see significant easing, so it’s possible that the best of this trade is behind us.

South Africa (ZAR) is no longer outright cheap, but still screens better than most when you factor in the large terms of trade gains. The FX benefited from an improving structural story: fading load shedding, gradual improvement in ports and freight rail, and a better inflation narrative, including the shift towards a lower, more formal target around 3%. The effect has been self-reinforcing via lower term premia, a stronger currency, and stronger bond demand. Fiscal dynamics have also been comparatively supportive, with knock-on implications for ratings. The first meaningful political interruption is the November 2026 municipal elections.

Poland (PLN) should weaken on fundamentals, but probably won’t. Fiscal deterioration and a deep cutting cycle relative to peers would normally be a headwind, but structural EU-related flows and the broader regional bid were enough to keep PLN strong and stable. It should benefit from any Russia/Ukraine ceasefire, but less cleanly than Hungary.

Hungary (HUF) is where politics dominates the macro. The upside scenario looks partly priced after the rally. The carrot for removing Orbán is a resumption of EU fund flows, though the current account is already positive at roughly 2% of GDP, so the story is not purely external financing. The complications are weak growth, pre-election fiscal looseness, and retail price interventions aimed at manufacturing a wealth effect into the vote. Even in an “Orbán loses” scenario, outcomes depend on the margin of defeat and whether a new, more powerful President (you know who) ascends.

Czechia (CZK) sits in the same low-vol Europe-gravity bucket. Babiš is a mild version of right-wing populism and any fiscal looseness is likely to be modest. It is hard to get excited about, but I regret ignoring it in 2025.

LatAm: carry plus value, still the rare combo

Latin America was as good an allocation choice in 2025 as it was a bad one in 2024. I think there are still opportunities.

Brazil (BRL) remains the standout, with the highest real yields in liquid EM while still screening on the cheap side. BRL can plausibly rally 10% before it looks stretched. Growth deceleration and disinflation exist, but not sufficiently for the BCB, and debt stabilisation still depends on the interest burden continuing to be marked down. One practical support seems to be that exporters convert the large trade surplus cautiously, which can provide marginal support on weakness.

Mexico (MXN) behaved better than fundamentals would have predicted, given sub-par growth and overvaluation. The compelling rates story likely helped attract unhedged bond flows. USMCA risk proved to be low down the list of global trade stressors, and post-election institutional concerns faded into the background. With the easing cycle now mature, the real rate buffer is lower and MXN becomes more sensitive to further Banxico easing than it was. Mexico’s structural appeal remains, but it feels like it’s in the price.

Chile (CLP) was the laggard in last year’s LatAm carry bonanza. The balance of payments improvement from the copper move has been underwhelming. The “missing windfall” story is sluggish output recovery plus leakage through the income balance: large dividend outflows to offshore owners, remittances, and other leakages. The Q3 breakdown illustrates the point: goods surplus around USD 2.38bn, services deficit around USD 2.28bn, and primary income around USD -4US 4.75bn. Copper price moves boost the goods line, but a material chunk is offset in income via repatriated dividends. Foreign ownership of mines is often cited in the 55–70% range, and even domestically listed miners have foreign shareholders. In 2025, the removal of election risk was arguably more important than copper itself, and there’s a chance of a positive reform story there.

Colombia (COP) is expensive and full of downside risks, but it also shows how far high real yields can take a currency in a friendly market regime. The 2026 election has primaries 8 March, general election 31 May, runoff 21 June, new administration 7 August. A bullish outcome is possible, but it is hard to see clarity arriving early enough for markets to lean into it decisively. The excessive minimum wage hike has pushed rates higher, which seems to have insulated COP for now, but the latent risk is fiscal premia becoming the dominant story, at which point flows can reverse quickly.

Asia FX: Some pockets of value

In the absence of compelling carry trades, domestic flow and official sector FX policy is key in Asia.

Korea (KRW) is the cleanest case of flows beating valuation. Persistent domestic demand for foreign assets and high outward direct investment appear to have outweighed the healthy current account surplus. The surplus is concentrated in a narrow set of corporates, who may choose to hold USD rather than feed it into the market. Looking into 2026, there are a few plausible supportive catalysts: likely WGBI inclusion with associated inflows (Apr–Nov 2026 window), potential NPS hedging of foreign asset holdings implying USD selling, and repatriation incentives via Reshoring Investment Accounts. The cheap REER is not a trigger, but it makes it easier for markets to justify chasing USDKRW lower if it starts moving.

India (INR) has been battling relative equity allocation and trade headwinds. One bank estimated around USD 19bn of portfolio outflows from foreign investors last year, alongside weaker exports to the US due to higher tariffs, with INR depreciating around 4.5% in spot terms. Potential positives are lower oil prices (BoP and inflation), lower US yields restoring the rates differential, and renewed foreign appetite for Indian equities. The RBI stepped back and tolerated depreciation for a period last year, then returned to smoothing. The cleanest upside catalyst remains a repair of the US relationship. I flagged this as a TACO opportunity last year, but sadly this one proved the exception.

China (CNY and CNH) was carefully managed through tariff tension and then USD weakness, and ended broadly flat across 2025. Most bank targets are on the bullish side but too small to justify being long once negative carry is accounted for. My base case is that China, facing Japanification-style pressures, avoids sustained FX appreciation because it would tighten conditions and hurt competitiveness. If USD strength returns, USDCNH can revert to being a boring long-USD carry vehicle.

Thailand (THB) was unusually influenced by gold and tourism. Thailand is a large gold processor which, in theory, should not make price moves material. However there did seem to be an effect, along with higher gold prices incentivising household selling of physical gold. The central bank would welcome more weakness given low inflation, ongoing easing, and fiscal tightening. There is an election on 8 February, which could bring de-risking, but the political backdrop remains difficult to trade cleanly.

Indonesia (IDR) suffered as more aggressive policy easing reduced the interest rate buffer that had been carefully preserved in past cycles. This was especially unhelpful at a time of deteriorating fiscal dynamics. Commodity terms of trade help, but the policy mix is not obviously FX-supportive. The appeal remains valuation and relative carry, and it likely needs either a policy pivot or a very supportive global backdrop.

Malaysia (MYR) outperformed on growth outperformance linked to AI-adjacent electronics exports and data-centre capex, with a surge in exports to Taiwan. On paper it is low carry and overvalued, which should cap appreciation. In practice it is highly correlated with broad USD moves and often treated as a loose CNH proxy. I’m biased to think of it as a funder, especially if the USD turns or the AI story slows.

Taiwan (TWD) was the policy whipsaw of the year. The central bank briefly stepped away during frantic life-insurer hedging post-Liberation Day, then stepped back in to restore order once the market leaned into the move. Suggestions are that life insurers reduced hedge ratios from around 60% to 40%. The large current account surplus encourages people to call TWD cheap, but on long-run REER it is close to fair value. Right now it remains a central bank reaction function story. The authorities appear comfortable creating the conditions for carry trading by locals once more.

Intra-EM FX RV: why BRL/COP keeps showing up

I want to include one intra-EM FX relative value idea that keeps resurfacing in BRL/COP. I think it’s a tempting example of a trade to put on when EM is not obviously cheap in aggregate.

The appeal here is that the valuation asymmetry is as wide as you could hope for.

But intra-EM RV trades can be dangerous unless you size them well and trade the noise. You have to vol-adjust the size of the opportunity and potentially begin by stalking the trade.

Having been stalking this one for a few months, I’ve watched up to 2% daily swings from pure noise. Even with the bid-offer, these are monetisable.

Intra-EM FX RV is one of the few places where FX can still offer real diversification. But I’ve found you need to be more selective than you might imagine from the chart. Most of the time the volatility tax is too high. BRLCOP might be one that’s worth it, but not unless you’re firmly strapped in.

Back to the calendar: USD boosted by midterms

The USD outlook is uncertain, but the base case has to still be that EM can survive what Trump has to throw at it prior to the midterms and later in the year the USD benefits from anticipation of his unravelling, or at least greater containment. That brings more challenges for EM in theory, but presumably with enough risk positivity to prevent too much weakening.

For me the regime change would probably come from one of three places: a term premium spike that keeps conditions tight even as the Fed cuts, a labour market rollover that forces a sharper repricing of the path, or a US-centric credibility shock that triggers hedging of outsized US exposure. If none of those land, EM can still work, but it works through carry, helped by equities and local rates flows rather than through standout FX opportunities.

Try to be paid for the risk you’re taking. Avoid taking FX risk for free. And do not confuse “quiet” with “safe”.

Signing off

Thank you for your time and attention. Please feel free to reach out with any feedback.

I continue these ad hoc notes to help organise thoughts, keep in touch with like-minded investors.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Leave a comment

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

In this note, I’ll discuss:

• The USD bounce - which I see as a lull that led to a position unwind.

• Sabotaging the USD revisited - I review the bear case for the USD.

• Tariffs and Immigration policy - I view these as brand damage and a productivity hit.

• EMFX - dangerously low risk premium, but frequent TACO opportunities.

The Eye of the Storm

After a month or more of marinating in benign US data and falling tariff uncertainty, markets were given a dose of reality at the beginning of this month, first from record payroll revisions, then from the firing of the head of the Bureau of Labor Statistics. The resilience in hiring was revised away, and that inconvenient truth was too much for the President, who prefers his truths with more CAPS.

In July, we saw speculative short USD positions liquidated, and a US equity market, led by tech, rising to new highs. As damaging tariff uncertainty appeared to be sliding towards resolution, the prevailing USD bearish narrative was fraying. For some, the pre-inauguration views were being dusted off. The core of that was higher for longer US rates, with tariffs seen as a US consumption tax hike plus a global growth hit delivered asymmetrically towards the rest of the world. US fiscal stimulus (via the post-inauguration tax bill) would support US growth expectations, and the Fed would keep the USD as a mid-high yielder among DMs.

In a sense, the BLS episode encapsulates the era we're navigating. Beneath each brief period of calm lies another potential shock: political, economic or institutional. Tariffs will never be truly settled, and the underlying economic reality will remain chaotic. Risk assets, meanwhile, have rallied behind a speculative veil, buoyed by the narrative that AI-driven equity gains signify imminent productivity miracles. Yet, bond markets remain sceptical, with elevated term premia casting doubt on the extent to which the real economy will feel the benefit.

So-called "victories" in recent trade negotiations mask underlying structural erosion: tariffs are imposing regressive taxes on US consumers, exacerbating inequality, and therefore undermining the long-term stability of the nation. The White House is chipping away at US soft power and at the institutions that help give the US its exceptional economic standing.

Right now, we’re in the eye of the storm, the post Liberation Day volatility has ceased, the USD has recovered some losses and investors are pausing for breath, and some are bracing for what comes next. This note explores precisely this disconnect as speculative and political veils distort market signals, suppress volatility, and misprice fragility. EM FX investors may wonder why an emerging markets strategy note continues to devote so much time to the United States. The reality is that, for now, there is an orange orb around which EM FX orbits. The instability Trump creates is defining the global opportunity set, and even at a country level, he has the capacity to move the price. I will discuss specific EM opportunities, but with the first principal component dominating, those views are several sections on.

Sabotaging the USD Revisited

When I wrote "Sabotaging the USD” early this year, I argued the Trump administration was intentionally or otherwise undermining the fundamental pillars that supported the dollar's long-term appreciation. As the USD sell-off pauses, it’s worth revisiting the core arguments and marking them to market.

I’ll pick what now seem to be three core areas: US asset positioning overweights, erosion of US soft power and institutional credibility, and shifting relative cyclical dynamics.

Asset Positioning: The global US overweight

US equity performance and inflows post-pandemic took the US share of global equity market cap above 50%. Large passive investors have allowed themselves to be overweight the US, and Liberation Day was a moment for reassessment. At the same time, the yield differential over most Asian currencies meant that USD holdings represented an attractive carry trade.

During April and May, US overweights were frantically hedged. Taiwan was the poster child of this flow. The failure of the USD smile to materialise during a crisis that was made in America eroded another pillar. The recent USD stability gives pause, but a full rebuild of that USD exposure seems unlikely, I would expect further trimming. US equities have staged a recovery, but it’s increasingly narrow. The only exceptionalism doing the lifting is tech. Anyone wanting AI exposure will likely buy US-listed names and this will keep a structural bid under USD assets for as long as the trend continues, or the bubble inflates depending on your viewpoint. This is one of the main tensions in the USD outlook.

Institutional and Soft Power Erosion: Waves of damage

Trump 2.0 opened with a volley of self-inflicted blows to US soft power. Early trade and security jabs at allies will leave a mark. Temporary calm from tariffs and NATO deals won’t last. There is no post-victory calm for Trump; he needs to keep the headlines rolling. Domestically, the attacks on institutions continue, with the Fed under pressure, and the BLS chief fired for delivering data that clashed with the preferred narrative.

Relative Cyclical Dynamics: The tough call

The macro read is still murky. Equity-driven easing in financial-conditions measures can make nowcasts and survey composites look better than the real economy, so the headline signal is flattered. Labour market weakness could be a short-lived tariff shock or the start of something deeper. Hiring has slowed, but layoffs haven’t accelerated. Consumption is soft, yet real wages and employment levels remain intact. Economists have eased back some of their growth downgrades, betting the shock will be spread over time. The latest payroll data tilts the risk back toward renewed USD weakness, but this is the hardest variable to price: the cycle could just as easily stabilise as roll over. What does seem clear is the asymmetry expected is not there: the hit to US growth expectations has been harder than we’ve seen in the EU or China, with the latter looking firmer than pre-Inauguration.

Trump’s Tariff Playbook and the Myth of Strategic Victory

Any USD strength on the notion that trade agreements represent a strategic victory is off base. I don’t think this can be called out strongly enough. These tariffs are politically expedient populism, not strategy, and they cause structural harm. Trump sells them as tools for reindustrialisation and a manufacturing renaissance. In reality there’s no coherent industrial policy. They aren’t foreign-funded either. The bill lands on US consumers and SMEs, with near-total pass-through to prices. Lower-income households carry more of the burden, small businesses lose competitiveness, cut investment, and the inequality gap yawns wider. That kind of regressive tax weakens the structural soundness of the US rather than strengthening it.

What hurts the USD is the chipping away at the trust and cooperation that underpinned US soft power. Allies now see the US as unreliable, and will hedge with new trade and security arrangements that will, over time, dilute American influence. The starkest own goal was the foreign-aid rug pull. Funding was yanked, pipelines broke, vaccines expired, and food programmes evaporated. Gratuitous harm for domestic theatre, and abroad, it looked like abandonment. That is how you squander decades of goodwill in a month.

What Real Strategy Would Look Like

A credible China-containment and re-industrialisation agenda would rest on three pillars:
Human capital - sustained funding for technical colleges, apprenticeships, and mid-career re-skilling aimed at fabs, advanced packaging, grid engineering, and precision machining.
Capital formation - multi-year tax credits and direct grants that de-risk private investment in semiconductor plants, battery supply chains, and transmission infrastructure; incentives sized to match the cap-ex curve, not the news cycle.
Allied alignment - tariff and export-control policy set in concert with Europe, Japan, and Korea, minimising retaliation risk and maximising collective leverage over China.

Get those three right and the US has a strategic industrial policy rather than a sequence of ad-hoc measures. Biden’s IRA and CHIPS Acts point in the right direction, but the Autopen needed to be on a bolder setting. Trump could, in theory, have used his political capital to amplify this framework; instead, the emphasis shifted back to headline tariffs and bilateral theatre. Strategy gave way to optics.

Immigration: the silent partner of US exceptionalism

In recent years the US has benefited from a common EM phenomenon. In China, three decades of rural-to-urban migration kept unit labour costs contained while factories scaled. The hukou system slowed wage catch-up in the cities. Cheap, elastic labour was the shock absorber that allowed capex to boom without immediate inflation. Mexico’s post-NAFTA manufacturing corridor used northbound migration and internal mobility to hold down wages relative to productivity.

Many EMs operate with thinner safety nets. The US achieved a similar effect by virtue of the status of much of its immigrant workforce. A deep labour pool let firms hire fast in upswings and release in slow patches without shifting the cost to the state. That kept services inflation lower than otherwise and helped the post-pandemic recovery run hotter with fewer people stuck on the sidelines. Set that beside Europe, where labour markets are tighter and the state absorbs more volatility, and the US enjoyed a cleaner growth-inflation trade-off.

The new administration is taking that buffer away, sharply. Hiring slows and gets pricier unless growth rolls over. Wage pressure shows up in construction, food, care, hospitality and logistics. Productivity still arrives, but diffusion slows: labour frictions and higher unit costs sit in the very services that dominate modern GDP.

Part of the dollar’s appeal is a flexibility premium: an economy that can move people quickly and absorb shocks with less fiscal strain. Undermine that and the US starts to look more like its peers; the growth and inflation edge over Europe erodes.

It’s Raining EM TACOs

My base case is for another leg of USD weakness. The main risks are the US cycle and AI-driven US Tech investment flows. Broadly, EM FX is helped by gradual USD weakening in the absence of volatility spikes. Given the current elevated equity valuations and tight credit spreads, risk premia are thin. With that in mind a safer way to express a USD short would be via currencies that are clearly structurally undervalued.

There is real value in parts of EM. China, Brazil, Chile and Korea screen as cheap on longer windows. India and the Philippines lean cheap on shorter windows. CEE and Mexico screen rich on both axes. The currencies that have lagged recently and remain structurally cheap are INR, CLP and CNY. The last of those is at the whim of official policy, and I expect the Chinese to continue to guard their competitiveness in the face of deflationary forces. Chile has taken the unusual step to rebuild reserves at a time of low valuation. For me, this means that the opportunity is more limited, and possibly one for a ratio option structure, playing for partial normalisation. India is most interesting and plays into the TACO theme.

TACOs in EM

The pattern is familiar now: headline shock, politicians posture, costs hit, carve-outs and delays follow, FX mean-reverts.

We saw this play out with China. The domestic economic cost was too high, which led to pauses, phased roll-ins, and a scaling back of the policy.
In Brazil, we have a good blueprint. The headline tariff shock pushed BRL weaker. Lula stood up to the bully, then Washington watered down lines that mattered for Brazil. The currency retraced.
India is the current candidate. We have already seen chatter of US product boycotts. The cost of broad US tariffs would hurt both sides. I would suggest that once more, exemptions, phasing and a backtracking are on the menu. India’s macro outlook is solid, with the current account deficit below 1%, which is small relative to its history. Growth expectations have stabilised after last year’s wobble. Reserves are ample.

The point is simple. In a world where tariffs are theatre, TACOs become a feature of trading EM FX. Wait for the sell-off, position for the climbdown.

Closing Thought: The Truths Hurt

Few positioned for the Q2 USD sell-off, yet many were caught short in the recent consolidation, FX is tough. We have discussed the key cross-currents: a murky US cycle and AI-led US equity inflows. What seems the more structural medium-term reality, though, is the persistent sabotage from the White House.

The hard truth is that tariffs are a tax on your consumers, not a strategic victory. Allies are being needled, not aligned. Institutions are being leaned on, not strengthened. The immigration buffer that kept services inflation tame is being stripped out. Each of these chips away at the growth and credibility premia that have underpinned the dollar.

The United States is being led by a keyboard warrior. When it comes to the dollar, the truths hurt.

Share

Signing off

Thank you for your time and attention. Please feel free to reach out with any feedback.

I continue these ad hoc notes to help organise thoughts, keep in touch with a wider community of like-minded investors. And for the sheer pleasure of writing.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Leave a comment

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Subscribe now

Sitting in the White House Oval Office, South African President Cyril Ramaphosa kept his composure while Donald Trump casually tossed false claims of genocide at him. The man who rails against fake news once again supported his accusations with the flimsiest of footage, this time featuring Julius Malema, a politician firmly on the margins of power in South Africa. The spectacle was, even by Trumpian standards, uniquely unsettling. The author of Trump Gaza, who eagerly entertains the idea that free speech has evaporated in my own country, the UK, now sees genocide in perhaps the only part of Africa he can reliably name. It also suits the project to nod in the direction of great replacement theory advocates. The performance was another example of the gravitational distortions now shaping global macro.

Because Trump is not just a political actor. He is the director of one of the three destabilising forces currently tugging at the global system, and the architect of another. This creates what might best be described as a Three-Body Macro Problem. Like Liu Cixin’s Trisolaran world, markets now orbit a system with no stable solution: only shifting alignments, temporary calm, and abrupt disruption.

The three bodies are as follows.

• First, the US growth–inflation tradeoff, growing harder to manage as fiscal impulse collides with rate expectations.

• Second, Trump’s policy chaos—fiscal, tariff, and diplomatic decisions driven by Trump’s ego and his priors.

• And third, the global recoil—a slow but deepening shift in how foreign capital views the US. Not just as a market, but as a partner. As a steward. I heard someone refer to this as ABUSA - Anything But the United States of America.

These three forces interact non-linearly. Together, they destabilise equilibrium. Just as the Trisolarans cycled unpredictably between stable and chaotic eras, so too do markets now shift between soft-landing hope and systemic volatility, with little warning, and no clean model to rely on.

Markets, meanwhile, have been enjoying relative tranquillity, but may have missed the ominous foreshadowing from the Oval Office. The recent tariff truce with China was abruptly disrupted on Friday by fresh threats aimed instead at Europe, with a 50% tariff announced for June 1st. It’s unclear if this marks the beginning of a new phase or just another keyboard outburst from a man incapable of strategic alignment. The stated aim remains US reindustrialisation to counter China. But the execution seems to involve antagonising allies more than adversaries, laying bare the breadth of its incoherence. Once again, strategic thinking is absent. Policy flails in unpredictable arcs.

Traders must now confront Trump’s political physics: unpredictable gravitational swings in which brief periods of calm alternate with sudden collisions. Markets exist within this unstable orbit, subject to interactions between domestic macro tensions, erratic executive power, and the world’s creeping loss of trust in the US as an anchor.

We may now be transitioning back into chaos. These disruptions aren’t anomalies. They are a part of our new normal. Tariff threats are blunt weapons wielded by mood. If negative reports reach him from a colleague or through his TV set, the fingers start tapping a new missive. The institutions that once imposed predictability, such as central banks, courts and treaties, now operate inside a system tilted off-axis.

The Three-Body Macro era is upon us. What follows in this note explores how to navigate it.

In the remainder of this note, I will discuss:

• The Framework - Where do we stand?

• 100 Days of Failure

• The Trump Cycle

• Sabotaging the USD Revisited

• Asian EM FX

• Country-specific notes - Brazil, Turkey, Poland and Hungary
  

The Framework - Where do we stand?

In past notes, I’ve often referred to a framework for thinking about EM FX. One element I call the Dragon–Greenback Squeeze. This describes the twin pressure of expensive dollar funding - tight Fed, a strong USD - and a compromised Chinese growth engine. Overleveraged, overmanaged, and underdelivering. That squeeze has become key to a soft period for EM assets. It’s occasionally interrupted by fleeting Goldilocks windows, when soft landing hopes deliver falling volatility, enabling carry strategies to perform. EM credit only seems to require the absence of acute threats, but high-yield EM FX requires more pronounced vol suppression.

If global macro is now orbiting through something like a Three-Body system, the vol suppression moments are becoming briefer. Are we in one of those calmer windows now?

It depends on how two key US risks evolve. One is recession, which could soften the Fed and the dollar. The other is acceleration, should the US economy not weaken enough after the tariff shock to begin a recessionary feedback loop, then loose fiscal policy could drive a rebound. Any rebound, given current levels of inflation, driven higher by tariffs, will give the Fed a headache. “Too Slow” Powell might become glacial when it comes to cuts at least.

China is treading water. Growth expectations have steadied with the help of targeted fiscal support, but the policy mix still looks cautious. There’s no major credit impulse. Real estate remains a drag. Policymakers seem focused on containing fragility rather than reigniting growth. That lowers the risk of a tail event, but also limits the upside. It’s a floor, not a launchpad.

US growth forecasts have become erratic and more dispersed. The tariff threats in March uniformly dented expectations. Some of that was reversed after the de-escalation with China, but the data remains noisy. Inflation is still sticky. Fiscal policy is undisciplined. A hard landing remains possible. So does another wave of price pressure. What’s certain is volatility, both in the data, and in how the Fed might respond.

EM is caught in the middle.

China isn't strong enough to pull global beta higher. The US might not be weak enough to anchor rates. Both economies are unstable enough that a single data point or policy announcement could swing sentiment. That makes directional EM calls more fragile. But relative value opportunities still exist.

We are still in what I’d call a Chaotic Interlude. It feels calm on the surface, but only because we’ve paused, not because anything has aligned. The Dragon–Greenback Squeeze is intact. The difference now is how fragile the path forward has become. And in this regime, the dollar remains the most sensitive asset for signalling stress and recalibration.

100 Days of Failure

A hundred days in, and Trump 2.0 already looks like a wreckage of bungled projects. The attempt to squeeze China seems to be backfiring, strengthening its global position just as the White House tries to undermine it. His push for a Nobel Peace Prize is faltering on multiple fronts. And there's a real chance he’s laid the groundwork for a recession later this year.

He hasn’t escaped the patterns of Trump 1.0. Yes, he now has more loyal backing inside the White House. But his attention span and pain threshold remain too short to push through effective change. The echo chamber around him makes him more likely to adopt the wrong strategy and stick with it longer than he should. He’s still an incompetent populist, and he’s still bad for America.

That, oddly enough, is a kind of relief. It means he’s less likely to drive us into the truly dangerous territory that markets began to price in before he blinked on tariffs. He lacks the discipline and tenacity for sustained damage. But what we’re left with is slower decay. A gradual erosion of institutions, the rule of law, and the US’s international standing.

This is already being priced. It encourages portfolio diversification away from the US and chips at the soft power premium embedded in the dollar. It undermines faith in the executive’s role in future crisis management. It casts doubt on the reliability of swap lines, the rule of law, and broader institutional response. For now, risk markets remain comfortable with these elements. But when the cycle turns, the safety net might not be where it used to be.

The Trump Cycle

Much has been written about Trump’s psychology, but it remains the cleanest lens through which to understand his behaviour. His narcissism is well known, and textbook. But it's the deeper emotional wiring that provides the real insight.

Every decision is filtered through a single question: does this make me look like a winner? That stems from a childhood shaped by conditional approval, distant parenting, and the transactional lessons of his father. Praise came through dominance. Affection was scarce. Loyalty became a survival need. Humiliation became existential. That wiring never changed.

This is why Trump treats politics as a test of personal loyalty. There is no overarching strategy, no 9-dimensional chess, it’s driven by emotion. He doesn’t build coalitions. He doesn’t negotiate in the usual sense. He seeks submission. That’s why so many of his staff exit in disgrace. It’s not about the job they’ve done, it’s about acts of betrayal.

Like any other toddler, he is easily bored. Real governance doesn’t hold his interest. What he craves is the opening act, the grand gesture, the emotional sugar rush of dominance. And so we get the rhythm of Trumpian policy:

• Infatuation Phase:
  He becomes enamoured with an idea when it offers immediate admiration, dominance, or narrative control. Ending a war? Perfect. He gets to be the great man bringing peace.

• Conditional Commitment:
  His attachment is shallow. It lasts only as long as the idea continues to flatter the ego. Once the headlines fade or complexity creeps in, the energy wanes.

• Devaluation Phase:
  If the idea begins to look weak or threatening — if it risks public embarrassment — he starts to mock it. The same proposal that once made him feel like a winner becomes “unfair,” “boring,” or someone else’s fault.

• Abandonment or Rebranding:
  He either drops it completely or reframes a partial outcome as total victory, even if the substance is lost. Saving face matters more than finishing the job.

This cycle repeats across themes, tariffs, immigration, foreign policy, and even the Fed. He wants to play the hero in act one and be applauded before act two begins.

His authoritarian instincts are real, but shallow. He’s not trying to redesign the state. He’s trying to bend it toward personal gratification (and enrichment). Obedience matters more than competence. Flattery more than expertise. Victory more than outcomes.

And this should shape how we read markets. The next escalation will not come from a grand plan. It will come from a slight, or a fear, or the need to regain narrative control. That makes the environment unpredictable, and more importantly, unhedgeable through conventional measures.

Sabotaging the USD Revisited

Back in March, I wrote Sabotaging the USD - that looks increasingly like the right framing.

Over the past two months, the great and the good have flipped their USD views. The new USD bears won’t write much of a mea culpa, even though most of them were expensively late. I’ll do my best to lay it out for them here.

The turning point for many only came in April, when the recently tight relationship with relative rates broke down dramatically.

Post-election, pre-inauguration, the consensus was for higher US rates and slower global growth. That was supposed to drive the orange line higher and take the USD with it. Yes, the dollar was expensive, but for good reason. The US was exceptional from a productivity perspective and also offered carry, superior equity returns (via tech), and risk-off utility - via the USD smile thesis.

The USD rallied into the inauguration, but faltered quickly after on the weight of positioning. Early rhetoric suggested Trump might be soft on China, and fragile USD longs didn’t have the patience to wait for tariffs.

Embedded in the bullishness on US exceptionalism was misplaced optimism on the growth side. Many assumed Trump would return with a focus on deregulation and business-friendly policies. They looked past the risks and treated Trump 2.0 as a rerun of 2017. Instead, we got rapid fire, erratic policy and escalating trade uncertainty. Reciprocal tariffs. Diplomatic confrontations. Poor communication. Late reversals. It was enough to trigger a confidence shock, and this time the driver was domestic.

That changed the dollar narrative. It was no longer just about relative rates or growth. It was about institutional credibility and the perception of competence. Growth forecasts were revised lower not because of external shocks, but because of policy uncertainty coming from the White House.

The later de-escalation with China helped a bit on the growth side, but didn’t restore credibility. Now markets are weighing the short-term cyclical relief against longer-term structural damage.

On valuation, I still don’t see the USD as particularly extreme. When you adjust for productivity and trade gains, it’s expensive but not wildly so by historical standards. Below is an updated version of a chart I produced in a prior note. This lack of extreme overvaluation means you require other factors to extend the move.

In the near term, I remain biased to a weaker USD. US growth risks are still skewed to the downside. Some may argue that the worst of the tariff news has passed, and markets can look through soft data. I’m not convinced. Markets often trade the data twice. Once when expectations move and once when it hits. Even telegraphed transitory data can feel less transitory when you’re in the middle of it.

Longer term, I don’t think we’re headed for a collapse in the dollar. But I do think we’re in a period of reappraisal. The political risk premium has risen. The soft power advantage has narrowed. That changes how the USD trades, even if it doesn’t change the reserve currency story.

The sabotage is slow, but visible. And it’s coming from inside the office.

Asia FX

Recent discussions around Asia FX have reopened some familiar debates, particularly in light of ongoing adjustments in USD valuations and regional trade dynamics. Some recent local feedback from local investors, and revised forecasts suggest a market increasingly split between tactical positioning and structural hesitancy.

Taiwan stands out as a good microcosm. Local lifers appear to be divided. One camp sees persistent USD softness ahead, with equity inflows driving more USD selling by exporters and retailers. This group is active, using NDFs and proxy hedges. They are pushing multiple pairs lower. Another camp believes the move may have largely run its course. They view the strength as a political signal to Washington during trade negotiations, and are now exercising patience.

KRW is the most obvious proxy hedge for TWD. It’s cheap, liquid, and allowed to move. It reflects similar structural dynamics and may also benefit from official preference to show willingness to appreciate the Won. It looks particularly attractive on a valuation basis, even after the dollar reversal.

CNH/CNY remains more controversial. The currency is cheap, but Beijing’s preference for stability remains paramount. The daily fixings continue to shadow a weak dollar but favour depreciation against the basket.

Recent local data also shows increased exporter FX conversion and rising forward hedging by residents, both signs of tactical adjustment, not a regime change. Capital is still leaking. Domestic demand is soft. Rates are low. A clean CNY rally seems unlikely and undesirable. The currency may not move much, so it’s potentially attractive as a low-beta short, which might fit neatly into relative value Asia baskets.

The broader regional picture still leans toward selective longs. Based on carry-adjusted valuation, INR and IDR remain solid, particularly with oil prices capping current account concerns and local central banks still leaning dovish. On the other side, MYR and CNH remain attractive shorts, both for valuation and flow reasons. TWD is may be too hot to handle - but the large valuation shift, the exaggeratedly low yields make it more of a candidate to be on the short side in a USD-neutral basket.

Growth momentum remains weak across the board. The reacceleration in Malaysia last year made it an outperformer, but the currency is no longer cheap, reserves are relatively low, and the country is exposed to any re-escalation in China-linked trade tensions.

Again, I lean on the above chart to visualise the carry-versus-valuation landscape, where INR and IDR cluster in the favourable quadrant and KRW and CNH sit in the undervalued-but-low-carry corner. The rest, MYR, THB, TWD, sit awkwardly, both rich and negative carry.

None of this suggests a clean regime. But in a world where relative value might be more tradable than directional conviction, these asymmetries could offer an edge. Especially when you accept that policy predictability in Asia, while imperfect, now looks remarkably disciplined next to the disorder coming out of Washington.

Notes on selected other EMs

Brazil
This still sits as the cheapest and highest carry of the major liquid EM currencies, so the burden of proof falls on reasons not to be long, at least on a relative basis. One such reason might be an overly dovish pivot from the BCB. That said, in a recent group webinar with Galípolo, he made it abundantly clear that temporary disinflation prints won’t shift policy. The stance remains restrictive, and the move toward scenario-based rather than forecast-led guidance should temper expectations of early easing. The real risk should still lie on the fiscal side. Lula’s approval ratings are in decline, and the temptation to deploy populist fiscal tools is rising. For now, the CB seems focused on credibility over responsiveness, and structural stickiness in monetary transmission, particularly in credit and labour markets, suggests rates may stay high longer than the curve implies, supporting the BRL.

Turkey
As with all carry trades, the key is to size for survivability and lean in after the cleanout. That might favour the current moment. The recent VaR shock flushed out much of the leverage, and in a small-format session with a member of the MPC, there was a notable shift in tone. Liquidity management apparently now takes precedence, with intervention policy tweaked accordingly. The disinflation narrative is being embraced more confidently, and private credit conditions are tightening in a way that reflects genuine macroprudence. A benefit of the political shock and policy response. Conversations with the real sector seem to be shifting. Firms are openly discussing hard landing risks. The central bank seems content with the current FX glide path, which still offers attractive returns.

Poland
PLN remains, on my metrics, the most overvalued currency in the liquid EM complex. And while the macro remains solid, recent post-election calls with local experts highlight growing uncertainty around the presidential run-off. Trzaskowski’s underperformance and Mentzen’s stronger-than-expected showing have altered the path forward. Should Nawrocki win, institutional reform efforts would stall, and the coalition could lose momentum heading into 2027. That’s not a volatility event per se, but for a currency trading rich to most models, it creates a clear asymmetry. The NBP under Glapiński will remain unpredictable. The risk here is more institutional than cyclical; EU flows are supportive, but should be in the price. As last year taught us in Mexico, never underestimate the power of political change.

Hungary
HUF has recovered well, still screens attractively on vol-adjusted carry, and is cheaper than its regional peers. At face value, the setup looks compelling. In a recent roundtable with two NBH deputy governors, there was the usual reassuring caution and desire for FX stability. The central bank recognises the disinflation trend but is reluctant to lean into it too far. Core inflation is sticky, and recent food price controls suggest fiscal discipline may be slipping again. Surveys point to fading business investment, which I read as having an undertone of regime pessimism. For me, the tension between monetary discipline and fiscal opportunism leaves me sidelined. If I see another broad risk-off brewing, locking in a good entry point long EURHUF might work.

Closing Thoughts: The Three-Body Macro

This note began with a metaphor, but it ends with a framework. We’re not just dealing with noise. We’re navigating a system governed by three competing forces:

• The US growth/inflation tradeoff — sticky inflation, patchy productivity, and an uncertain path for rates

• Trump’s policy agenda — a mix of expansionary fiscal drift and disruptive tariffs, without strategic coherence

• ABUSA — the global pushback against US leadership, where trust in the dollar, institutions, and alliances continues to erode

None of these forces are new, but their interaction is what matters. Like the three suns in Liu Cixin’s novel, they pull against one another, destabilising the old orbits and making prediction less useful than preparation.

For markets, this means volatility is the regime. The dollar still benefits from inertia and a lack of alternatives, but the soft power premium is leaking steadily. Some may still look to the next data print for clarity, but the structural story is one of drift and disorder.

This is not a return to chaos. It’s the recognition that we never left.

The Three-Body markets are here. The orbits won’t settle. Trade accordingly.

Share

Signing off

Thank you for your time and attention. Please feel free to reach out with any feedback.

I continue these ad hoc notes to help organise thoughts, keep in touch with a wider community of like-minded investors. And for the sheer pleasure of writing.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Leave a comment

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Elgie holiday snap

Subscribe now

Epcot, Rockets, and the Return of the Trump Put

A badly timed family holiday to Florida this past week left me watching markets through a Chinese assembled iPhone, mainly in queues for rides at Disney. Being flung around at high speed in the dark probably sounds a lot like what most traders were experiencing last week.

My kids met an America that sits in strong contrast to the one they watch from home. At the Kennedy space centre, they saw images of bravery and common purpose. At Epcot, they saw optimism about the future and a carefully choreographed illusion of global harmony. Seeing America at its greatest, they could finally understand the desire for a MAGA message. Out there in markets, efforts seemingly to make America a manufacturing powerhouse again were going down badly. Perhaps it wasn’t optimal to deliver tariffs that looked like they were calculated by the intern and announced in the style of a playground bully. At NASA, listening to the words of some great American leaders, the contrast couldn’t have been starker. Some Americans need to be reminded that they were “not descended from fearful men”.

In response to the tariff announcements, the early US forecast revisions were to ratchet higher inflation and trample on growth. The childish delivery was almost guaranteed to deliver some retaliation. Proud nations can’t be seen to cower in front of a bully, and China, the world’s largest economy on PPP adjusted terms, was never likely to do so.

Before Trump blinked, we had gotten to the point where positions were thrown out regardless of merit, and high-yield EMFX was trading very much like a risk asset. As well it should. As discussed before, carry must be considered relative to vol, and when the vol gets this high, the carry can become deeply insufficient compensation for the risk.

By the end of the week, we had learned that there was indeed a Trump Put. The sharp sell-off in treasuries after days of equity losses seemed to be enough. Trump took the logical step of narrowing the focus of his tariffs. It never made sense to take on the world, and maybe this is the start of the process of making peace with former allies and narrowing the focus of policy. Reindustrialisation where it’s desirable, without trying to restore textiles or tariff penguins.

Regardless of how this plays out in the coming weeks, I think we can confidently say we’ve seen Paxxit. The slow, deliberate dismantling of the post-Cold War economic architecture that once anchored global confidence. The immediate macro implications may turn out to be only a small part of the story.

PAXXIT

What the US has just done - regardless of the size of the majority or the consensus among the population - is walk away from the political and economic architecture it built and led. With the painful parallels to Brexit - I think of this as Paxxit. The end of Pax-Americana.

The US no longer sees itself as the neutral steward of the system. The dollar, US capital markets, and the rule of law were all historically offered as public goods; now, they are being reframed as assets to be weaponised. If you’re a foreign central bank or multinational company, you’re watching this unfold and quietly reassessing your exposures.

The notion of rules is being replaced by grievance. Tariffs are no longer tactical, they’re pegged to bilateral trade deficits, regardless of the cause. That’s not policy; that’s emotional accounting. And the risks go beyond goods flows. Investment regimes, corporate access, and legal protections all start to wobble when reciprocity is defined by hurt feelings and fear rather than WTO schedules.

What will worry investors is that we’re on the road to eroding trust in the system. Institutions that used to act as anchors, such as the US Treasury, the Fed, and the courts, are no longer seen as sacred. This may not matter to most people today, but in a future crisis, it might. Will the Fed extend swap lines to EMs as quickly and freely as it has done in the past? Will US regulators still act in predictable, technocratic ways? Or will it all become part of the same transactional fog?

Markets can’t have fully priced this yet. Structural credibility isn’t something you mark to market until it’s gone. For now, risk premia remain mostly focused on recession risks. But the ice beneath global capital is thinner than it looks.

That’s Paxxit. A break not just from globalisation but from the US’ role as ballast in a storm. We may muddle through in the short term. But long term, this is the sort of shift that only becomes obvious in the rear-view mirror.

Sabotaging the USD

In early March, I wrote a note titled Sabotaging the US Dollar. At the time, the title felt provocative. It doesn’t anymore.

We’re now seeing the bear case for the USD come into focus. This is less about the trade balance, more about the erosion of what made the dollar exceptional. Deep markets, rule of law, a sense that capital parked in the US was capital that would be respected. The tone that Trump 2.0 has struck and the sloppily expressed views about allies from members of the regime (I’m looking at you JD) are hurting the brand. As I mentioned before, the S&P 500 Index derives a significant portion of its revenues from international markets. Most notably in its globally leading tech names, where some sources suggest close to 60% of revenues are derived from overseas consumers. Below, we see what might be the first step towards unwinding the dominant position US equities held in global markets.

Up until last week, the weakness in the USD against the majors was based purely on the changes in macro expectations. US rates were high relative to other DMs, and thus, the global downturn had a relatively greater impact on the US curve, causing differentials to turn against the USD. That regime ended abruptly towards the end of last week when the relative rates and FX diverged sharply.

There are still no credible candidates to replace the USD as global reserve currency, but at the margin, there is a shift in preference, along with a strong suggestion that US assets are on the table as a weapon of the trade war.

EM FX: Carry, Chaos, and the Good Quadrant

I’ve been cautious towards EMFX vs the US since the election, with the policy mix containing damaging dynamics. The growth implications for China - while offset to an undetermined amount by stimulus - remain very negative. The outlook for USD funding is unclear as we wrestle downside growth risks with another round of inflationary shocks, coming at a time when we were struggling to polish off the last of the previous course.

Last week, we entered a regime where high yield EMFX traded as a risk asset, and all that mattered was the single factor (or the path of the rollercoaster). If the emergence of the Trump put stabilises markets and sees declining vols, then we may once more be in a position to pick winners. With the amount of disruption, it seems ever more prudent to avoid expensive currencies and to have a higher bar for carry trading.

I frequently refer to this chart comparing valuation and carry. The good quadrant is obvious: cheap currencies with carry. Chile is attractive but will be rewarded only if we see sufficient stimulus from China. South Africa has seen a reemergence of political risk, and we may see multiple cycles as the uneasy allies within the GNU fight to maintain credibility amongst their core supporters. Indonesia looks to have taken sufficient idiosynchratic pain in the near term, with a priority shift from the central bank hurting the IDR.

MXN, helped by softer tariffs, isn’t cheap enough to be really compelling, especially with such a weak cyclical position. Brazil still seems to offer sufficient risk premium to be a highly compelling long, despite the unresolved fiscal concerns. Although, one must be mindful that too deep a fall in Lula’s popularity could provoke a dangerous fiscal reaction. In Asia, Korea, on valuation grounds must be considered as a relative long.

Turkey: Still Carrying the Weight

March marked a significant turning point for Turkey. On March 19, Istanbul's Mayor, Ekrem İmamoğlu, a prominent opposition figure and potential presidential candidate, was arrested on charges of corruption and alleged ties to terrorist organisations. This move was widely perceived as politically motivated, aiming to sideline a key rival to President Recep Tayyip Erdoğan. The arrest ignited the largest anti-government protests Turkey had witnessed in over a decade. Hundreds of thousands took to the streets across major cities, expressing their dissent against what they viewed as an authoritarian crackdown on democratic institutions.

In line with stated priorities, the treasury and the central bank kept to their orthodox inflation-fighting priorities and absorbed capital outflows. With the TRY long the best FX sharp ratio trade of 2024, there were clearly some big leveraged positions, and the VaR shock that occurred necessitated a sizable unwind from offshore investors. Locals have so far been more sanguine (with their deposits), which makes sense to me. This bout of political risk comes with rates dramatically higher than in past episodes, and the central bank has successfully shown the cost of holding USD over a significant period. As long as local dollarisation remains muted, the TRY carry trade will continue to look compelling. The overwhelming base case is for another period of very high sharp ratio returns - albeit with higher political risks and elevated implied vols.

​I joined a bank call with Simsek recently. While he didn’t comment on “ongoing judicial processes”, there was an undercurrent of realpolitik creeping in. He casually commented on how the global order was changing. Implying that Turkey is more important now in a multipolar world. He’s right, too. Hard power is back in fashion; Turkey knows it, and Erdogan will get more international leeway as a result.

Central Europe: Watching the Clock

Hungary remains problematic. The base case is a deterioration in fiscal dynamics as we head into elections next year. Orban has little interest in restraint and every incentive to juice the economy. The market has given him the benefit of the doubt before. I’m not sure it will again. The changing world order might offer Orban more scope for democratic backsliding, but the EU won’t. We could reach a critical point in that relationship, and the HUF will be a key release valve.

Poland has a different issue. Winning the presidency is key for the civic platform to push on and replace key offices and pursue past corruption cases. Polls point strongly towards this outcome, so a messy election represents a tail risk that international investors could be slow to wake up to. With PLN as expensive as it is, the risks seem asymmetric going into the vote.

China: The CNY Conundrum

China has plenty of retaliatory tools. Tariffs were the obvious first step, but the currency remains a key tool. Traders have been washed around in the CNH trade this year, with heavy USD longs into the inauguration hurt, then USD shorts caught by the escallating tit for tat tariffs. On the case for stability in USDCNY, we know China values stability - especially in a crisis. They won’t want to invite capital flight. Also, broad USD weakening allows them to depreciate with a stable USDCNY.

So far, they have devalued the CNY subtly, allowing modest depreciation against the USD via the fix and more so against the basket. In some ways, the size of current tariffs is so large that any FX-based mitigation seems less pressing.

Brexit, Tribalism, and Harari - a final personal indulgence

Paxxit isn’t just a macro story. It’s a social and political one. And like most regime shifts, it rhymes.

As a Brit, I’ve seen this film before. Brexit was never really about trade. It was about belonging, identity, and the seduction of an imagined past. The slogan said “Take Back Control,” but the message was about grievance and exclusion. And when the policy costs began to bite - slower growth, weaker institutions, diminished global standing - people didn’t walk it back. They doubled down.

Not because the data supported them. Because tribal identity mattered more than policy outcomes.

I get the same sense with the current direction in the US. Tariffs are the surface layer. Beneath them lies something deeper: the instinct to view global interdependence not as strength but as betrayal. Economic self-harm isn’t seen as a mistake, but as sacrifice, an offering made on the altar of national identity. Many would clearly rather reshore than redistribute - even if it shrinks the overall pie.

Markets treat this as an error that can be corrected. But what if it isn’t? What if it’s the point?

This is where I find myself thinking of Yuval Noah Harari. I’ve long considered myself a disciple of his framing. His insight is that humanity’s strength lies in our ability to build shared myths. It’s those myths that allow cooperation at scale. But when the myth breaks down, what remains is power and tribe.

The liberal order that grew out of the postwar years had a myth: growth, peace, open markets, and rational governance. But the gains weren’t shared. The institutions grew aloof. And no new story came to replace the old one when it started to fail. The 2008 financial crisis showed the cracks in the system, and these were never closed.

Progressive politics tried to offer a new story, but it hasn’t stuck for much of the population. For some, it feels like a language they didn’t choose, a morality they didn’t vote for. The result has been a cultural backlash and a return to old anchors: religion, tradition, family, and nation. Not because they are working, but because they are familiar.

Without compelling new stories, the old, failed stories are being recycled. In the case of Trump’s America, it’s nationalism in a new package. Less Reagan, more grievance. Less aspiration, more control. The strongest voices on the other side risk recycling failed stories of socialism.

What concerns me isn’t the short-term hit to GDP. It’s the long-term corrosion of the architecture that made cooperation possible. And the vacuum where a better story ought to be. When I grew up, America was the shining city on the hill. A place of scale, innovation, and optimism. Its stories of freedom, ingenuity, and fairness shaped the world I expected to live in. At Disney, those stories are still going strong. My kids felt it. But they’re not enough on their own. Without leaders who believe in them and work to keep them alive, they start to feel like relics - comforting, familiar, but detached. At the Kennedy Space Center, you can see who’s filling the gap now. Bezos and Musk are the ones carrying the torch, not the state. And the space those old civic stories used to fill doesn’t stay empty for long.

Signing off…

Thank you for your time and attention. Please feel free to reach out with any feedback.

I will continue these notes ad hoc to keep in touch with a wider community of like-minded investors.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Leave a comment

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Subscribe now

We’re only a handful of weeks into the new US administration, but it feels like six months in terms of news flow. People talk about dog-years moving at 7x the rate; Trump-years seem even greater. Consuming policy announcements (and pivots) is like drinking from the firehose, and what’s been coming through isn’t as bullish as markets had anticipated. The first Trump administration taught his critics in the market that it’s unwise to bet against the US with him at the helm. This time around, market participants were optimistic about lower taxes and deregulation and prepared to stomach (or cheer on) some pretty hard right politics. Those with a penchant for crypto were excited about what lay ahead, especially with Elon in the Oval Office. Immediately after the inauguration, I wrote about the USD, expecting that US exceptionalism would continue - at least for a short while. Today, I have a few more arguments against this view, and I want to explore them in detail in this note. I won’t talk too much about EM - but getting one’s big dollar call right is critical to making money in EMFX. I’m mindful that the half-life of any analysis right now is 24 hours, so I will present both sides of the argument.

In this note, I’ll cover:

• What’s happened since the Inauguration

• The case for USD strength

• The case for USD weakness

What’s happened since the Inauguration

Initially, the USD pulled back after the inauguration as tariff policy was slow to emerge - particularly against China, and what we did get looked more aimed at gaining leverage. USD longs were reduced, and the market prepared itself for a wait-and-see period until the April 1st reports land. The USD traded in a range for much of February, bouncing on tariff escalation and sagging on more dovish US growth developments. Policy came fast, but ascertaining the end state or the true strategy seemed like it would take a while. Mouthpieces of the regime and Trump-allied talking heads have been working overdrive to steelman the latest action or ‘truth’. The grand strategy is alluded to, and Trump is presented as a man playing 7-dimensional chess, but we don’t learn a lot in the process. There is an argument that tariffs on allies will be light and that the true plan is to tackle China’s more tangibly unfair trade practises. There are several issues with this, one being the strength of the rhetoric against allies, another being the recent action to bring forward postponed tariffs, and the final one seems to be the lack of regard for the economic cost of uncertainty.

It’s become increasingly difficult to brush off the way the Whitehouse has conducted itself in geopolitics and its approach to government employees. The DOGE actions will have both a real impact on the labour market, as jobs cuts materialise, and an impact on sentiment. The economic activity of government employees and those of businesses that work with the government will be depressed until clarity emerges. The latest US retail sales report was weak, and more timely indicators from banks on credit card spending, as well as consumer sentiment surveys, have pointed to weakness. The politically polarised US consumer had divergent views on future inflation at the start of this year - but expectations of higher inflation have begun to permeate the partisan barrier, and that’s further bad news for consumption. The US consumer, supported by strong real income growth, has been the mainstay of US growth outperformance in recent years.

Forecast revisions are lagging more so than usual, with economists highlighting the rising downside risks to their forecasts whilst being slower to publish downgrades. At the time of writing, the market is digesting a modestly soft nonfarm payroll report, with little to raise alarm; it was a miraculously dull event in such a wild environment. Nonetheless, this was the last of the pre-DOGE employment reports, with next month’s release expected to be messier. Trade-related data has been clouded by the process of frontloading in anticipation of tariffs. In the rest of the world, we’re seeing a modest upswing in China on the back of stimulus measures and the anticipation of a potentially game-changing fiscal expansion in Europe in response to Trump’s novel approach to the Nato alliance. I think we can agree that recent relative equity moves don’t look very MAGA.

In my last note, I wrote, “to truly weaken the USD, I suggest Trump would need to sabotage the US economy.” This has very much entered the narrative in the past couple of weeks. Trump inherited an economy that was outperforming globally, and its capital markets were hoovering up an increasing share of global savings. I thought the impact of tariffs would initially be bullish for the USD. Economists widely accept that tariffs would do more damage to growth in the US’s trading partners than it would at home. Had we seen an administration focused purely on tariffing China and engaging in business-friendly policies at home, then I’m confident that US exceptionalism would be in overdrive. That’s not been the movie I’ve been watching lately, and so the debate over the USD’s 14-year uptrend is live.

The case for the USD

Let’s review the argument I made 3 trump-years ago (25th Jan). The current long-term uptrend has been in place since the US began its journey towards becoming a net energy exporter in 2011. This is not the only way the US has outperformed over the period. US productivity growth has outperformed its DM trading partners. There have been several phases of outperformance after economic shocks, with US productivity recovering faster from the financial crisis and the global pandemic. Productivity is one of the most definitive variables in currency valuation modelling, and the US has been exceptional.

Factoring in this productivity outperformance and the terms of trade gains can recontextualise the valuation argument around the USD. Below, I have calculated two adjusted REER series, factoring in these variables. The literature on the appropriate coefficients is mixed, so here, I’ve used something in the middle of the range of estimates. On this analysis, the starting point for the USD looks less extreme going into 2025.

The prevailing trend of technological gains helping to drive ever greater wealth inequality generates a glut of investable savings. The most attractive destination for these savings experiences upward pressure on its currency. With some of the highest yields in developed markets and an equity market containing dominant tech players, the US has more to offer than just a ‘safe-haven’.

FX is a relative game, and the USD has benefitted from weak growth in the other two largest economic areas, the Eurozone and China. In the wake of its housing market downturn, China has been in the grip of deflation. Declining interest rates in China and the region have led onshore corporates to hold more USD than they might have in the past, and global investors have migrated away from many asian bond markets. The Eurozone’s growth underperformance has been more structural. Post-pandemic and energy-price-driven inflation eroded real incomes more so than in the US, leaving a significant growth differential.

To summarise our USD bullish arguments:

• The US loses less than others from tariffs.

• The USD is strong but not as overvalued as the raw REER suggests.

• China remains structurally weak (deflation, property crisis, capital controls).

• Europe is a slow-growth, rate-constrained economy (I’ll get to the fiscal news separately).

• EMs have serious fiscal constraints and external funding risks—they’re weaker, not stronger, post-pandemic.

• The market always has to park capital somewhere, and the US remains dominant because of productivity, tech leadership, and deep capital markets.

• If the Fed doesn’t ease aggressively, US yield differentials should support the USD.

• The USD remains a necessary liquidity and collateral asset. It won’t lose position as the global reserve currency - there is no alternative.

• In any global stress scenario, USD shortage effects kick in, reinforcing its dominance.

• EM and global corporates still need USD funding, keeping demand for USD intact.

The case against the USD

I can’t go any further without touching on the recent news out of Germany. Trump’s special blend of international diplomacy has successfully persuaded European leaders that the transatlantic alliance is a historical artifact and is not to be relied upon in future. There was a gentle trend in the direction of higher defense spending in place already, but what we’re facing now looks like a strategic shift that also impacts European defense manufacturing. This is where the art of the deal looks to have introduced undesirable consequences for US arms manufacturers. European countries’ spending more on defense is good for NATO and the US. The outcomes the White House has achieved look bad for NATO and US firms. This alone is not bullish for the USD. The consequences of fiscal expansion in Europe is bullish for the EUR. Germany, a relatively low-debt country, has artificially constrained itself for years, and it looks likely to now use the significant fiscal headroom it has. This has implications for European growth and inflation. This stimulus has already been felt strongly in markets. It would be unusual if such a shift were priced in within a few days.

On the macro side, we’re looking at upside risks in Europe and downside risks in the US. Relative rates is a strong driver of currencies, and anticipation of weaker relative performance of the US vs the European economies has already begun to be priced. It is the strongest driver of the chart above. Having talked about fiscal easing in Europe, we must acknowledge the risk of fiscal tightening in the US. That seems to be favoured by Musk and many of the traditional republican thinkers orbiting the President. Trump himself seems to favour tax cuts, and the recent budget bill points to fiscal expansion. However, we have to be mindful that the direction of travel in the world’s largest economy, accustomed to running huge fiscal deficits, is at risk of changing. We might find out how much of the US exceptionalism story was down to fiscal largesse.

There is another reality for the USD in the relative rates story. The USD currently enjoys a significant yield advantage over much of DM. In a world where trade wars are driving lower growth outcomes across the globe, the Fed has a lot further to ease than most of DM. Rate differentials narrow materially if major central banks all use their available headroom.

Another potential downside risk for the USD is the damage to the US brand globally. Tesla is the poster child of this phenomenon, but it won’t be alone. Whilst there may be some in Moscow who have recently become more favourable towards the US, there won’t be many joining them elsewhere. The Trump administration, regardless of the desired end-state, has succeeded in portraying the US negatively in the eyes of its allies. Whether it’s JD Vance lecturing the Europeans, regime adjacent figures playing fast and loose with Naziesque gesticulations, or Trump himself publicly musing about annexing neighbours, none of it represents good marketing. The S&P 500 Index derives a significant portion of its revenues from international markets. Most notably in its globally leading tech names, where some sources suggest close to 60% of revenues are derived from overseas consumers. As some US tech brands suffer by association with what some foreigners see as the emergence of a gangster state, others are being challenged by Chinese competitors. Recent strides in AI from China have dealt a blow to the perception of US dominance in this technology. US equities represent 50% of global exchange market cap - up significantly in the last 2 years. There seems to be scope for a reversal of this trend, which would presumably hurt the USD.

In addition to damaging the brand for international consumers, there seems to be a risk to US institutions. Good governance is key to the long-term success of an economy (ref. recent Nobel prize-winning economists). Under Trump’s previous administration, we saw a deterioration in governance metrics. Looking back, it feels like Trump 1.0 was a tame rehearsal for what we’re likely to get this time. The most worrisome element for the USD would be any efforts to undermine the Federal Reserve. This risk rises if Powell, when presented with weak growth and high inflation, fails to ease as much as the regime might like.

To summarise our negative USD arguments:

• US growth hit by policy uncertainty, tariff-driven inflation fears and budget cuts.

• Trading partners stimulate due to geopolitics (EU) and to counter trade wars (China)

• Foreign holdings in US assets are at extreme levels—there’s simply too much capital to unwind without a USD impact.

• Asian corporates & sovereigns hold large USD reserves, this presents risk of diversification away from the USD or repatrication.

• If tariffs hit growth hard, the Fed has more room to cut than Europe and Asia.

• Trump damages US soft power (international reputation), which hurts US businesses and equity holdings.

Summing up

It’s not easy to make a long-term judgement on the USD. I sense that Trump might moderate policy in response to market moves, with the ‘Trump-put’ becoming common parlance. If the White House sees the value in more targeted actions, such as focusing tariffs on a small group of countries or industries to achieve specific, well-communicated goals, then the USD can recover some of its losses. Against targetted countries, it may even make new highs. China seems to be patiently waiting for clarity before deciding its FX policy response to Trump. It’s possible that despite how messy and asymmetric his initial peace efforts over Ukraine have been, he pivots to a more neutral stance and delivers something sustainable, repairing his international reputation along the way. I’m convinced that those in the market who are fans of Bessant and Navaro fully expect this course of events and are waiting for Trump to be proven an imperfect but effective tool for change.

For me, and in the near term, it looks like there is already irreversible damage to the brand and the economy. Allies will not be easily persuaded that the US is a reliable partner, and events set in motion will continue. There are some more extreme, dark scenarios permeating our psyches. A US moving towards authoritarian rule, allied with Russia, working to annex allies. A US led by men who are looking to a future multipolar world where the US has to tread on its former allies for strategic gain. A world of rearmament in Europe and perhaps nuclear proliferation. Even brief episodes of contemplating such seismic change are enough to upset the status quo. The status quo has been US exceptionalism. That may be over, and with it will go the strong US dollar. If a goal of the new US regime was to weaken the dollar, then they found the only route I could see - sabotage - in that, they’ve been successful.

Let’s briefly touch on what this means for EM, an asset class crying out for a weaker USD. Sadly, the mechanism of weakening is problematic. Tariffs will hurt growth in many EMs. Global risk aversion might hurt US equities more than EM equities - especially given the valuation starting point - but it may not be outright bullish. My sense would be to continue to target currencies of countries where tariffs are most likely to stick, China and its closest trading partners. Against this, find refuge in undervalued currencies, such as BRL, CLP, ZAR and IDR. The EUR may do well even from here - potentially also against highly overvalued EMs such as PLN and CZK.

Signing off…

Thank you for your time and attention. Please feel free to reach out with any feedback.

I will continue these notes ad hoc to keep in touch with a wider community of like-minded investors. I’m still enjoying life at Argo, where debate is lively and risk appetite robust.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Leave a comment

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

The calendar has once again exerted its influence on markets and research production. Positive pnl's are reset to zero (negative ones not so much...) and inboxes are inundated with year-ahead outlooks. This isn't one of those. Here I will provide an update on where we stand in the wake of Trump’s second inauguration, with a brief recap of 2024. In many ways, we’re in a similar environment for EM FX to the one we've experienced for the past year so it should be informative to review what's worked.

I wrote a post-US election update in mid-November, laying out expectations for USD strength, and some of that has played out. In these first few days of then Trump/Musk regime, we’ve been experiencing a buy-the-rumour-sell-the-fact USD pullback - helped by the impression of a more dovish approach to tariffs on China. My bias here is to patiently fade this dynamic.

Looking at the medium term, US and Chinese political choices will dominate. For the EM FX investor, Chinese currency policy will be key. For the equity investor, the broader Chinese fiscal package will dominate, along with retaliatory tariffs.

The foundation of my FX view is that the initial phase of Trump 2.0 will extend US exceptionalism (the word popped up in his inauguration speech multiple times) and that he will eventually focus tariff policy on China. Rhetoric from Trump and the broader party towards China has been consistently hawkish, and it would be surprising if there were any lasting ‘deals’ on this front. Talk of currency cooperation belongs on the fringes.

In this note, I’ll be discussing:

• Review of 2024 EMFX performance.

• The Framework - where we stand after recent developments?

• The Broad USD - how expensive is it?

• Where does EM FX stand on key metrics?

• USD/CNY - Trade of the year, or let down in waiting?

• Country specifics - Brazil and Turkey - starkly diverging policy paths.

Subscribe now

Review of 2024 EMFX performance.

Despite high carry - LatAm was the worst-performing region. It’s the region with some of the weakest fiscal dynamics, and that was a significant theme in 2024, no more so than Brazil. Persistent disappointments over Lula’s fiscal policy drove currency weakness that couldn’t be arrested even by the sharp reversal of policy by the BCB. Eventually, interventions were successful in delivering some stability. This “burning of reserves” was met with the usual scepticism, but I’ve learned over the years that such episodes can be turning points. MXN began the year overvalued, so it’s less surprising that it had a difficult year. Weaker growth and an election outcome that damaged confidence in governance were key sources of negativity.

The Asian low yielders performed well on a NEER basis - only TWD depreciated. The USD strength early in H1 provided steady carry-adjusted returns for those shorting these currencies, but the US growth scare in August caused a deep reversal which was not fully retraced even once it had been proven to be a head-fake. KRW was the big under-performer among the Asian mid-yielders with messy politics adding fuel to an already weak picture.

In CEEMEA, ZAR held on to some gains despite the post-US-election sell-off. The positive momentum in South African assets and optimism over a more centrist phase of politics couldn’t cope with the USD rally and treasury weakness that characterised November and December. EURPLN traded almost like a managed pair, turning out to be a great place to earn high-vol adjusted carry. HUF latterly performed poorly, as fiscal concerns began to re-emerge. TRY was a carry machine - with short-end rates at 50 and a heavily managed exchange rate.

In all - 2024 was a dangerous year for EM FX trading, broad weakness and sharp reversals made for a treacherous environment. I expect this year to be similar. Avoiding accidents, cautiously accumulating carry and looking for mean reversion will be the way forward.

The Framework - Where do we stand?

In past notes, I’ve discussed the structural challenges for EM from what I call the “Dragon-Greenback Squeeze,” which represents the high cost of USD funding vs. China's faltering growth engine. This structural drag—which is still very much in place—is partially offset by periods of goldilocks-driven low volatility, which makes risk attractive.

Hopes of a softer USD and stronger Chinese growth were raised some months before the US election. These were dashed on all fronts firstly by a correction in US rate expectations, then by a petering out of optimism over China Stimulus, and finally by the Red wave (see past note). This leaves us firmly back in the grip of the dragon-greenback squeeze. This is a sadly familiar set-up now for EM. Once again we are faced with US assets outperforming, and crowding out EM.

The persistence of the EM bear market for flows has left us with some more attractive valuations, which should eventually tip the scales. However, momentum is against EM and it's difficult to imagine a broad wave of investment into these value bets. For this, we would need to see a change to the fundamental setup.

In China, we have seen some pick-up in growth expectations resulting from the stimulus measures already announced. Meanwhile, inflation forecasts continue to be revised lower.

In the US, the election outcome and expectations for stimulative fiscal policy and deregulation have raised growth forecasts. Inflation forecasts moved higher, too, with tariffs playing the largest role.

We are yet to gain clarity on many aspects of US policy and there is scope for significant revisions to the US outlook. In China, we await details of their stimulus plans and await their response to US tariffs. This leaves our key variables in a state of uncertainty. Given the unfavourable nature of the set-up for EM, this uncertainty might offer more hope than fear. My bias is to expect China to be aggressive on the fiscal side, particularly in the event of a US-driven shock.

The Broad USD - how expensive is it?

At the time of writing, the USD is pulling back from recent highs. This wave of inconvenient USD weakness appears to be a cutting of excess positioning built up ahead of the inauguration. As discussed in my previous note, the consensus nature of the long USD trade is strong enough that we are going to be vulnerable to pullbacks. During such pullbacks, we have to determine the likelihood of a medium-term turning point. One reason for caution is that the USD screens as ‘overvalued’.

If we look at the USD’s real effective exchange rate (REER), we can see we’ve exceeded the highs from the last tech bubble and sit 15-20% above the 30-year average. With FX being an RV business we should look at which currencies, of those that dominate the REER, the USD performed particularly strongly against. In the chart above I look at the REERs of the major trading partners (and USD REER components) since the beginning of the USD uptrend. Here we can see a strong contribution from the weak Yen, where currency devaluation is baked into the policy mix. More recently the Mexican Peso has suffered from fears of overreach from a more powerful leftist government. The start of the USD uptrend came with CAD weakness, which has yet to reverse.

The current long-term uptrend began around the time the US began its journey towards becoming a net energy exporter. This is not the only way the US has outperformed over the period. US productivity growth has outperformed its DM trading partners. There have been several phases of outperformance after economic shocks, with US productivity recovering faster from the financial crisis and the global pandemic. Productivity is one of the most definitive variables in currency valuation modelling, and the US has been exceptional.

The US equity market has also been exceptional, with its dominance in the tech sector delivering excess returns year after year. When we compare the US exchange market cap with the rest of the world we can see the US having caught the rest of the world, particularly in these last couple of years.

Going into the inauguration the DXY rally has closely tracked relative-rates spreads. This suggests the USD’s strength is in line with its macro outperformance. In my experience, rates markets tend to follow fundamentals more reliably than FX. Trump may talk about wanting lower trade deficits, but those deficits are the balancing item to the large capital account surplus that the US enjoys, by sucking foreign capital into its equity and bond markets. The mighty orange one talks of making the US exceptional - it already is.

Is there a bearish longer-term narrative for the USD? Something needs to change to turn the current narrative around. The USD could weaken due to near-term growth underperformance that leads to lower rates. Most economists consider this unlikely, with US recession probabilities paired back since last August’s slowdown head-fake. The latest employment reports have been strong, and high real wage growth keeps US consumption, a key engine of growth, well supported.

To weaken the USD Trump could collude with other nations. If he wanted lower trade deficits he’d have to collude on the capital account side by persuading them to hold lower USD reserves. This is potentially damaging for Treasuries, raising the cost of funding his widening deficit. To me, it would seem unlikely, given his adversarial approach, to make an accord with his rivals.

To truly weaken the USD I suggest Trump would need to sabotage the US economy. Whilst this seems unlikely in the short run, with deregulation efforts and lower corporate taxes both positives, it’s possible in the longer run. Institutional strength is key to the long-term success of an economy (ref. recent Nobel prize-winning economists). Under his previous administration, we saw a deterioration in governance metrics, and many expect more of the same.

Many also question the impact of his policies on US soft power and US global leadership. The appeal of maintaining the system of USD dominance in the global economy has been declining for some time. The lack of credible alternatives has held up the process of diversifying away from the USD so far, as evidenced by the huge pickup in Gold buying by central banks. Trump may well add to the motivation. With this being such a huge topic and this being an EM FX note - I may publish further on the broad US Dollar separately.

Where does EM FX stand on key metrics?

As always, 2 key axes worth monitoring in EM FX are carry and value. Avoiding highly overvalued currencies can serve you well even if trading value as a theme produces inconsistent returns. For example, the overvaluation of the Mexican peso left it far more vulnerable to the political shocks (and a growth slowdown) in 2024 than otherwise might have been the case. Here we should be cautious of PLN and CZK. Considering these axes together one might find some longs and shorts that could balance well in a portfolio.

As you can see above, the US growth scare delivered a lasting blow to carry strategies in Q3 last year, from which they did not recover. Relative carry still looks attractive, and these strategies might be able to flourish in 2025—particularly if the tariff skew is towards Asia.

Looking at vol-adjusted carry, we can see one reason why the PLN has become so expensive. INR and TRY were so closely managed until recently, that Carry/Vol would destroy the chart.

USD/CNY - Trade of the year, or let down in waiting?

With China trade conflict yet to break out some might suggest that Trump is afraid to take on the powerhouse that China has become. Perhaps like the playground bully he often seems to embody, Trump would rather pick easier targets. They may wish to take more time to calibrate their attack, knowing that the stakes are higher with China than with other competitors. Whilst he may happily threaten other nations with tariffs to gain leverage in a deal - with China, we are likely moving toward a concerted phase of economic warfare.

The CNY was kept in check during the post-election broad USD strength with the fixing kept stable and authorities defending the top end of the trading band. During this pullback, they have taken the opportunity to move the fixing lower. It seems reasonable that China would wish to avoid provoking the US by allowing a devaluation ahead of tariffs. The CNY is already a competitively priced currency. Years of deflation with a significant inflation differential to most of the globe, have helped keep exports very competitive. China can afford to wait to calibrate its response to any tariffs.

Equally, for anyone holding long USDCNH via the forwards, time is on our side. The rate differentials remain attractive for foreigners and domestics to hold USD over CNH/CNY.

I still think long USDCNH offers strong risk-reward for 2025. Whether it turns out to be a huge trade this year, or something more modest remains unclear. Either way, it may be a trade that rewards patience and dip buying rather than aggressive accumulation and vol buying.

Country specifics - Brazil and Turkey - starkly diverging policy paths

At opposite ends of the spectrum for 2024 total returns, BRL and TRY both look attractive today, albeit for very different reasons.

The Turkish central bank continues to view currency stability and modest real appreciation as a key tool in their inflation fight. They’ve repeatedly communicated their desire to change the local mindset towards the currency, and offering low volatility and real appreciation for a significant period is their recipe. Below left I highlight the forwards and two rates of depreciation. I suspect we will occupy the space between the blue and yellow lines this year I see good odds of earning double-digit returns. They will likely look to transition gradually away from such aggressive vol suppression, but I suspect that will be several quarters away.

BRL, which has started the year well, will tempt investors with outsized real rates. One has to venture into frontier markets to see real rates anywhere near what Brazil is offering. Unless we think Brazil belongs with the likes of Egypt & Nigeria, rather than Mexico and Colombia, we should be tempted to trade BRL from the long side. The central bank intervened significantly to the tune of $21bn in the spot market, partly to soak up seasonal dividend outflows. This came after a period of significant depreciation and alongside the announcement of 300bps of rate hikes. 100 already delivered, and 200 more pre-committed to. The fiscal outlook for Brazil is still immensely challenging, and I expect more volatility ahead with locals highly skeptical that Lula can exercise caution ahead of an election year. Nonetheless, this intervention and the level of real rates both skew the odds in favour of the BRL, at least in the short run.

Share

Signing off…

Thank you for your time and attention. Please feel free to reach out with any feedback.

I will continue these notes ad hoc, as a way of keeping in touch with a wider community of like-minded investors. Argo had a successful 2024, and I’m still enjoying engaging with my new colleagues and reconnecting with the industry.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Leave a comment

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Image by DALL.E

I didn’t intend to write a note until the end of the year, but clearly, recent events are overwhelmingly significant for EMFX. This will be a brief update on my initial thoughts on the consequences of the Red Wave and the return of the now all-powerful Don.

My last note struck an optimistic tone. We had a compelling combination of macro dynamics with the potential to deliver positive tailwinds to some heavily beaten-up EM assets. This hasn’t been entirely washed away by the Red Wave, but much of it has been, at least in the short term.

In this note, I discuss the following:

1. Philosophical take on the result (feel free to skip this personal indulgence).

2. Summary of macro-economic hot takes.

3. EMFX performance review

4. Implications for EMFX and the framework.

5. The USD.

Subscribe now

Philosophical Take on the Result

The election result has been distressing to many, though not surprising. To my mind, it’s further evidence of the chaotic times we’re living through. Centrist liberal politics has struggled to deliver results in the face of multiple headwinds. Demographic challenges, technological progress and pandemic spending have strained government budgets and increased inequality. The return of inflation to developed economies has affected cost-of-living pressures that squeeze the lower end of the income distribution. The internet and social media provide unprecedented transparency into the wealth and lifestyle gap, fueling envy. Incumbent parties have paid the price in elections across the globe, as voters crave change and protest the outcomes their leaders have delivered for them.

We’re in the early stages of adapting to our new media landscape, where information has exploded in volume but not in quality. In his recent book Nexus, Yuval Noah Harari draws a parallel with the invention of the printing press. He highlights that this innovation didn’t usher in the Enlightenment, as commonly assumed, but rather a period of religious wars and witch hunts. It was only with the founding of scientific institutions and the rise of academia that the Enlightenment—and its benefits—truly arrived. The complex and costly process of arriving at truths skews the odds in favour of simple fictions. Perhaps the AI revolution will eventually deliver tangible gains on this front, but for now, we have a sea of lies and half-truths to wade through.

In moments like these, financial markets have additional appeal. No matter how large the volume of information generated about a topic, the market processes it into a price change. This process is undertaken by organizations and individuals on a capital-adjusted basis, effectively giving more weight to those with a stronger track record of making accurate predictions. The market might not always deliver a convincing verdict, but it usually does an honest job of representing the direction of travel.

In turbulent times, we can seek refuge in markets as they interpret likely economic paths. Translating one’s views into trades and observing the market reaction as news unfolds is a great way to process events alongside millions of other participants—and with luck, make some money along the way. As financial markets adjust to the election outcome, there’s an opportunity to assess whether the market under or overreacts to shifting expectations of policy. We can also assess how well it identifies potential winners and losers across the world.

We have months to speculate on what this Trump administration will implement. Some in the market had hoped for a more moderate version of Trump, one who might hire moderates and spend more time on the golf course. The early signs suggest this is wishful thinking.

Summary of Macro Impact

The incoming Trump government has strongly indicated a combination of domestic tax cuts and trade tariffs. The tax cuts will likely come in the form of extending Trump’s expiring tax cuts from his last administration, along with a return of corporate tax rates back down to 15%. This aligns with the minimum level under the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) agreed upon in October 2021.

Tariff expectations vary, but the overwhelming consensus is that China will be singled out for the largest increases—60% was mentioned during the campaign. Across-the-board tariffs have also been discussed, although most economic forecasters are excluding these from their base case scenarios.

During Trump’s last term, China tariffs were often circumvented by rerouting trade through third countries. Vietnam and Mexico were commonly mentioned, with good evidence supporting these claims. The analogy fits well with the trade displacement resulting from Russian sanctions. Trade usually finds a way, although friction and costs are incurred. There is every reason to expect the incoming administration to learn the lessons from the past and directly challenge this rerouting.

The conventional view is that Trump’s policies are inflationary for the U.S., with mixed but net positive effects on growth. Tax cuts and deregulation are growth-positive, while tariffs act as a consumption tax hike, which is growth-negative. In the current environment, both measures are inflationary. This suggests we have to expect the U.S. easing cycle to end earlier and at a higher level of rates. Tougher immigration is another policy focus, which will hurt labour supply. This, too will be inflationary and negative for potential growth.

For EM, the impact is less ambiguous. Tariffs are negative for targeted countries and their trading partners, while a diminished Fed easing cycle will strengthen the USD and increase the cost of capital for EMs.

EMFX Performance review

Let’s begin with our usual exercise of looking at how EM FX nominal effective exchange rates have evolved.

The USD weakness seen after the August US growth scare was felt most strongly in Asian low-yielders. Since September, US data surprises have recovered strongly, and even before the election, the USD had recovered significantly. CNY, THB and MYR have held on to some of their gains, and are still up on the year. I don’t expect that to persist. IDR and INR have faired relatively well, with the highest carry in Asia, Korea has struggled, with the Kospi one of the weakest equity markets globally.

In CEEMEA only the resurgent Rand has flourished. Encouraging disinflation, hopes of reform, and an increased ability to keep the lights on have driven positive feedback loops in rates and FX. It also benefits from being a rare case of an EM high yielder with improving fiscal dynamics. Hungary has been going in the opposite direction. Despite its caution, it seems that the NBH compressed real yields too far and left investors with insufficient risk premium.

LatAm has been a graveyard for EM investors this year. Seemingly, the pervasive pessimism in Brazil over Lula’s desire and ability to address the deteriorating fiscal dynamics knows no end. Polarised politics has delivered a uniformly sceptical set of local investors, and in the absence of inflows into EM, foreigners aren’t there to provide a sufficient counterweight. Mexico has lurched from domestic governance concerns and weakening growth dynamics to fears over Trump tariffs.

Implications for EMFX and the Framework

In my last note, my only solid call was a bullish view on USDCNH—a view that remains intact. However, much of the broader framework is now under significant strain.

Going into the election, markets were already shifting from U.S. growth fears to concerns about "no landing." While the initial stabilisation of growth expectations was positive, the subsequent repricing of rate expectations posed challenges. The inflationary shock now looming significantly raises the risk of a "high-for-longer" U.S. rates environment. This delays the positive feedback loops I anticipated—lower U.S. rates, a softening USD, and capital flowing into EMs. As a result, EMFX is broadly unattractive.

The market provided an opportunity to get long USD on Day 2 after the election. A combination of short-term positioning, wishful thinking about a moderate Trump, and expectations of a China stimulus announcement caused the USD to weaken below election-night levels. This was both an excellent opportunity and a warning for the environment we’re entering. Consensus on the USD is overwhelming, and for good reason. The likely policy changes clearly favour the USD. When consensus is this strong, the challenge becomes judging position size and knowing when to lighten up to buy dips. The noise Trump will generate—on top of macro data—will ensure a bumpy ride, especially as most agree on the direction.

My personal preference is to own USD against CNH and other low-yielding Asian EMs. Here you have the carry on your side as you target both a strong USD and headwinds for the EM economies closest to the most probable and largest set of trade tariffs.

Elsewhere I think you can divide EMs into losers and non-losers from the red wave. The non-losers will be the countries not heavily involved in affected manufacturing supply chains and not likely to catch the ire of the Don. LatAm FX ex-Mexico contains many of the non-losers. Sadly, as discussed in prior notes, it contains some of the most worrisome fiscal stories.

The Turkish Lira remains unaffected, as do some other controlled exchange rates where the FX is a policy tool to facilitate disinflation. That process is far from complete in Turkey, so as long as they remain committed to the fight one can enjoy the carry on offer. When rates are at 50%, TRY shouldn’t flinch at a 1% swing in US terminal rates.

My favoured approach here would be to park the desire to own high real-rate currencies until such time as they get eye-wateringly cheap, or if there are reasonable expectations of positive fiscal developments. We will remain in a bear market for EM flows for the foreseeable future, and that means more opportunistic trading and less static longs. I will be watching the backup in USDZAR for a potential entry point - this is the best story in high-yield EMFX right now. As the most favoured high yielder, there’s potential for an overshoot.

Mexico is a wildcard in the Trump story - here I can see the negatives resulting from a clampdown on its role in the China supply chain, but I can also see the potential for a deal. Trump loves a deal, and maybe Mexico can help him make a success of his immigration policy in exchange for some leeway on the trade front. There's every chance that MXN can return as an EM darling in 2025.

The USD

The USD entered this Trump episode more expensive than it did his previous term—over 10% higher in REER terms. This naturally raises concerns about overvaluation, but I find these concerns unconvincing at this stage. To me, valuation serves as a guide to the potential magnitude and speed of currency moves rather than their direction. I like to target cheap or expensive currencies but rarely engage unless there is a catalyst. Overvaluation can persist well beyond my investment horizon.

If the forces acting on the USD remain supportive, appreciation is likely—though the magnitude may be tempered by its elevated valuation.

One can also argue that the extent of overvaluation is overstated. Productivity differentials are a well-accepted factor in currency valuation, and the U.S. has seen significant productivity outperformance in recent years. This should mitigate the REER-based overvaluation concern, providing further justification for staying constructive on the USD.

The U.S. remains ‘exceptional’ in multiple respects. Its shale revolution has ensured energy independence, while Silicon Valley has created globally dominant businesses that continue to flourish. The performance of the S&P500 has outstripped nearly all assets globally, and continues to attract capital to the U.S. These structural advantages combine with the USD’s position as both a safe-haven and a relatively high-yielding currency. The combination of these factors makes the USD uniquely appealing in the current macro environment, against the deteriorating appeal of most other currencies - damaged by the threat of tariffs.

Consensus trades are dangerous, and require careful management - but so early into a structural shift, this one looks compelling.

Subscribe now

Signing off…

Thank you for your time and attention. Please feel free to reach out with any feedback. As mentioned earlier, these notes will be infrequent but I look forward to checking in periodically.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Image from DALL-E.

Subscribe now

Since my last note, we’ve seen significant developments across the macro landscape. The Fed kicked off its easing cycle in September with an aggressive 50bps cut, which prompted the market to price in a further 75bps over the next two meetings, alongside more than 100bps for 2025. At the same time, US data surprises have been steadily climbing since July, with inflation surprises moving sideways - anointing the more constructive view on the disinflation process. Meanwhile, in China, the government has announced a raft of stimulus measures.

In this note I’m going to discuss the following:

• Recent moves in EMFX

• Where we stand in my framework

• China stimulus.

• FX Carry - opportunities and challenges.

• Brazil - if not now then when?

• External vs fiscal - still diverging.

Recent moves in EMFX

Let’s look once more at how EM FX has moved on a NEER basis—stripping out some of the USD move. Here, you can see some outsized moves from the low-yielders, notably MYR and THB. The magnitude of these moves took me by surprise. It’s clear that a substantial carry trade had built up across a range of economic agents throughout the US hiking cycle. The unwind was violent, with expectations of a reversal of USD hoarding by local corporates in Asia triggering heavily skewed demand. The big winner outside Asia has been ZAR, with lower US rates dovetailing well with a more centrist approach emerging from the new coalition government in South Africa. Meanwhile, many higher-yielding EMs continue to suffer from local political noise and deteriorating fiscal expectations, including Mexico, Brazil, Colombia, and Hungary.

Where we stand in my framework

The recent US policy repricing provides a tailwind for EM assets. Recent US growth data that challenges the scale of this repricing also provides the stability that risk assets crave. Importantly, the overall direction of policy remains supportive and represents a positive shift for EMFX and broader EM assets. Historically, US easing has supported capital flows into higher-yielding emerging markets. My base case is that this will be a shallow easing cycle, so it’s important not to get carried away by this shift alone.

In combination with US easing, recent stimulus measures out of China—while less impactful on their own—add further momentum to the EM story. China’s policy actions can stabilise sentiment around China-linked assets and currencies. The interplay of these two factors—the Fed’s easing and China’s stimulus—creates a more favourable environment for EMFX, easing the “Dragon-Greenback squeeze.”

China Stimulus

While I remain sceptical over the medium-term, recent developments in China's stimulus approach mark a decisive break from its previously gradual tactics, signalling a determined effort from the top to stabilise the economy. The combination of rate cuts, significant fiscal measures, and bond issuance reflects a "whatever it takes" mindset aimed at addressing multiple challenges. Notably, the increased bond issuance is expected to enable around 1 trillion RMB in additional fiscal stimulus, directed towards key sectors such as consumer durables, housing, and services like elderly care and healthcare.

The PBoC has also introduced new lending facilities, akin to the US TARF programme, designed to support financial institutions and companies engaged in share buybacks. This unprecedented move could establish a sustained floor for asset prices, particularly in equities. However, while initial optimism has buoyed markets, the real test will be whether these policies are effectively implemented to support a broader economic recovery.

In terms of currency, there is optimism for the RMB, which could benefit from renewed economic activity and potential foreign inflows into Chinese equities. However, the looming US election and the potential for a Trump victory with tariffs will soon dominate the narrative.

I won’t say too much about the US election—the polls are painfully close. My only view is that if one can find good leverage (and I think you can) in USDCNH call option structures, these should play a role in a portfolio. The limited historical precedent points to the Chinese authorities allowing significant currency depreciation to counter tariffs.

FX Carry - opportunities and challenges

FX carry remains a challenging theme in the current environment. On the one hand, the substantial drawdown suggests we could be at a ripe moment to buy the dip, following historical patterns. On the other hand, many of the currencies that would typically feature on the long side of carry trades come with notable risks. On the short side, Asian currencies are appealing given the potential for a retracement in US rates. This is complicated by the recent China stimulus and the tail risk of a material unwinding of hoarded USD in several countries. Below, I look at carry versus a simple measure of value (deviation from 10-year REER).

Among the standout carry currencies, the three usual suspects—COP, MXN, and BRL—remain prominent, though each faces challenges.

• BRL looks compelling on most metrics but fiscal risks have overwhelmed the positives so far this year.

• COP is particularly vulnerable to an acceleration of policy easing, which could rapidly reduce real rates and put pressure on the currency, especially given Colombia’s weak fiscal outlook.

• MXN has suffered from domestic growth deterioration and governance concerns. Stronger US growth expectations are a positive.

Adjusting for volatility (I use tail hedging costs) provides a more nuanced view. Here, our three Latin American carry friends—BRL, COP, and MXN—slip down the list as their vol-adjusted returns become less compelling. INR stands out as a favourable option, although the other top candidates appear expensive.

Two carry currencies that have recently performed are ZAR and IDR, both benefiting from increased demand for their bond markets. These remain strong picks but approach them with caution as short-term outperformance brings positioning risks.

It’s worth mentioning CEE currencies in light of these charts. They have periodically been profitable carry longs over the past few years, but at present, they look dangerously overvalued, and I would be very cautious.

TRY remains the stand-out carry trade in EM and has been performing well. I am forced to exclude it from many of my metrics given the extremes it occupies. As a managed currency - for now - it exhibits extremely compelling carry-to-vol dynamics, although real appreciation this year has made it look expensive. Recent poor inflation data seems likely to defer easing and to my mind reinforces the value of a stable currency. If policymakers retain their orthodox approach, then the TRY carry trade will have legs.

BRL - if not now then when?

Following on from the above, BRL screens compelling on several other metrics we’ve discussed before. The BCB has been pushed into a hiking cycle by a combination of currency underperformance and rising inflation expectations. The latter is partly due to an economy growing above potential alongside a tight labour market, both impacted by scepticism over the fiscal outlook. Brazil has one of the largest net deficits among the countries I look at here. While expectations haven’t deteriorated rapidly, a lack of confidence in the government’s ability to address these concerns weighs on sentiment. Moreover, there is a highly polarised political environment, and domestic market participants are heavily skewed against Lula.

Nonetheless, much of this should be priced in. Given the current negative sentiment, there is likely an asymmetric outcome to any new fiscal developments. To my mind, the hiking cycle is a clear demonstration to the government of the negative consequences of its current stance. Lula knows the country needs lower rates, and perhaps he can be persuaded to have a “come to Jesus” moment to make that more likely. As for the positives, the start of the hiking cycle has caused ex-ante real rates to reprice higher, placing them top of my list.

Currencies usually respond well to growth upgrades, and Brazil leads my list on consensus growth forecast changes for 2024.

So, we have rising ex-ante real rates, growth upgrades, the strongest combination of carry versus valuation, and a goldilocks backdrop, along with a China stimulus. If BRL trades poorly with these dynamics on its side, then the fiscal story must be deteriorating even further.

External vs fiscal - still diverging.

In my last note, I laid out my framework, highlighting the post-pandemic trend of weaker fiscal positions and stronger external positions. The weaker fiscal balances made sense given the higher debt levels and rates, while on the external side, weaker growth and depreciated currencies explained some of the phenomenon. This is an ex-post story, but what surprises me is that these dynamics persist despite easing and currency appreciation. A look at 2025 forecast revisions shows both trends.

As we can see there has been a continuation of the trend for improving external positions, with few exceptions.

Fiscal revisions skew heavily negative, led by Poland. It’s worth noting that beleaguered Brazil is far from an outlier in terms of deterioration, although high rates make for larger absolute deficits than most.

Larger fiscal deficits make currencies more vulnerable. Central banks aiming for stable exchange rates will have to offer higher real rates to offset these risks. Markets will punish countries with poor fiscal dynamics that ease rates too aggressively, even in a goldilocks environment.

Share

Signing off…

Thank you for your time and attention. Please feel free to reach out with any feedback. As mentioned earlier, these notes will be infrequent but I look forward to checking in periodically.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Image from DALL-E.

Subscribe now

It’s been an eventful first half of 2024 with lots to discuss, as we seemingly move towards the start of the easing cycle in the US, and with 6 months since my last note, it seems a good moment to take stock.

As I mentioned at the beginning of the year, these notes will be few and far between, given my commitments at Argo. I wrote a weekly update for a time, but that came to an end late last year when I joined Argo Capital Management, an EM-focused Hedge Fund. With their consent, I will write occasional personal views on the market. Argo invests in a range of EM assets from liquid macro-driven EM investments, similar to those I discuss in these notes, to distressed debt. FX is not a dominant asset class at Argo, and my activities cover a broader range of investments, but for these notes, I will continue to stick to EM FX.

In this note, I will discuss:

• Review of H1 2024

• Outlook

• A brief note on Trump

• A framework for the current EM FX environment

• IIF CEE Trip

Review

2024 began with an aggressively discounted Fed easing cycle with 7 cuts in the price, and some expecting that to begin as soon as March. By April, barely 1 2024 cut remained in the curve, as Q1 delivered consecutive upside inflation surprises in the US, along with a solid growth outlook. Today we once again have aggressive easing priced, but this time it’s a response to a notable softening in the US labour market, together with a reversal of the Q1 inflation surprises.

The recent repricing has come with significant market turmoil, including an equity correction and an unwind of FX carry trades - most notably those funded in Japanese JPY. The Japanese played a key role in the magnitude of the shock. The multi-year JPY weakening trend had become a concern for authorities in Japan, enough for them to begin trying to introduce jeopardy into the carry trade with FX interventions. They understood that while the large rate differentials between the US and Japan persisted, all they could materially impact was the vol-adjusted carry. They succeeded. After the most recent soft US CPI number the MoF elected to get behind the USD weakening impulse and deliver more intervention flows. This was the beginning of a 12% move down in USDJPY, which had repercussions for FX carry trades across EM - with the Mex Peso the largest victim. The carry shock came with a pullback in the outperformance of tech and large-cap US equities relative to the rest - this was another source of instability.

Meanwhile, on the macro side, we were comfortably into a run of negative data surprises in the US, Europe and China. US labour market data had been gently softening for months before a stinker of a payroll report triggered the tediously oft-quoted Sahm rule and the market lurched into full blown recession fears.

This recent period has been particularly challenging for EM FX. Prior to July, EM FX had been characterised by weakening low-yielders and volatile high-yielders. EM FX Carry had performed well for periods punctuated by selloffs. The Q1 US CPI surprises culminated in an April sell-off. In May/June we had an EM election-driven VaR shock, where 3 surprising election outcomes were enough to trigger liquidations. These were all characterised by USD strength, and losses on Carry were due to positioning factors and the higher beta of high-yielders. In this recent episode, low-yielders and high-yielders have moved in opposite directions, as the Asian currencies traded with a JPY beta. Below I compare the sell-offs.

Navigating these events was critical to managing EM FX risk in H1. After each unwind there were attractive levels to buy high-yielders, whereas the trend weaker in the low-yielders was more stable.

Looking at the performance of the nominal effective exchange rates in H1 we can see winners and losers in all 4 of the categories I split EM FX into. Among the low-yielders CNY outperformed due to its close management against the USD, causing a strengthening of the NEER. MYR belatedly outperformed significantly. In LatAm, the high-yielders underperformed, although there was less divergence prior to the elections in May. In CEEMEA, the positive election outcome and optimism over centrist policy led to the outperformance of the ZAR. PLN also outperformed with high real rates supported by an intransigent central bank head. Poland also benefits from a favourable flow story, notably substantial EU funds. Of the Asian mid-yielders, only INR performed, under a stable USDINR exchange rate in a strong USD environment.

A Brief Note on Trump.

After the debate, and prior to Biden stepping down, the market had a strong and uncomfortable look at what a Trump presidency could mean. The odds have now shifted, but Trump is still a plausible winner, and should his odds increase focus will return to the impact of deglobalisation policies, such as tariffs directed towards China. However, even if we think we know their direction, Trump's policy specifics are unclear. The details matter significantly when it comes to tariffs. If they are selective and of low magnitude, their impact can be quantified and small growth and inflation adjustments can be anticipated. However, 60% tariffs would seem impossible to model and could lead to compounding effects. Having sought FX stability of late, Trump’s policies may prompt the Chinese to allow the FX depreciation they have so far resisted this year. I’ve been bearish on CNY throughout H1, and this risk will keep me bearish through H2. US political noise resulting from a close election with divergent policy outcomes will create unhelpful volatility, as might any anticipation of a contested outcome. This volatility would naturally damage the appeal of the FX carry trade.

Outlook

There could scarcely be a more dangerous time to opine on the outlook than now. We could be at an inflection point for the US cycle, with significant ramifications for the USD and EMFX. Despite the unwelcome volatility, what’s unfolding does have the potential to create market conditions both more and less favourable than what we’ve experienced recently. Future paths can include those that are strongly EM bullish. For example, if soft inflation continues, it could allow a significant easing cycle in the US. It would require strong communication from the Fed that quickly convinces markets that easing will be aggressive in covering recessionary tail risks. In this case, capital might feel safe enough to exit the US in search of higher yields, leading to a USD downtrend. This could signal an end to what has been a bear market for EM flows.

The other side of the scale is more intuitive: if the slowdown gathers pace, it will continue to alarm investors, causing sufficient risk aversion for capital to flow back to the US and low-yielding DMs (like Japan). The USD would remain strong but volatile for a period, making EM treacherous.

My bias is that we’re not at an inflection point. I feel the current fears of a sharp growth slowdown are overblown, and some mean reversion could easily tip us back onto the path of a steadier slowdown. If the path is gentle, and US rate cuts are modest, the USD will retain its position as a mid-yielder. In this outcome, we are still likely to want EM FX Carry trades on an RV basis. This environment still gives room for idiosyncratic stories that are compelling enough to overcome the noise and be held as structural trades. One example would be the Turkish Lira, where a prolonged period of orthodox policy and high yields has resulted in sizable inflows. With spot relatively stable and no longer on a trend depreciation path, there seems to be a window to enjoy most of the 40+% carry available in the forwards. Policymakers seem to believe that the benefits of REER appreciation (disinflation and capital inflows) outweigh the costs. Short CNH also looks set to remain a structural trade that can be held in the medium term. The prospect of a Trump presidency adds a potential kicker there but is not a necessary condition for the trade to perform.

EM FX framework.

Given the high uncertainty over which regime we will occupy, I thought it worth devoting time to outlining the framework I’ve been operating under. This framework breaks if US rates are eased so much that the USD becomes a funder, and/or the slowdown is sharp enough to cancel ‘goldilocks’.

The fundamental baseline, I believe, is that we have been in a structural EM bear market, defined by weak Chinese growth and high US rates. The positive countervailing dynamic has been the ‘goldilocks’ US growth/disinflation balance which has calmed market volatility to such an extent that the higher yields in EM can look attractive on this ‘vol-adjusted’ basis. This dynamic has been good for EM credit and periodically good for the FX carry trade.

The Dragon-Greenback Squeeze

EM assets have spent many years responding to the rhythm of Chinese growth and US monetary policy. Chinese growth impacts global trade dynamics, commodity prices, and overall economic sentiment, which in turn affects capital flows and investment in EMs. US rates have a significant impact on the flow of capital into higher-yielding EM assets. Lately, we have had weak growth in China and tight US policy. This unhelpful combination is something I’m going to call the “Dragon-Greenback Squeeze” (DGS).

The Dragon

Since last year, the medium-term outlook for Chinese growth has remained subdued. I recall writing at the time that I thought the previous growth model had hit the buffers. Housing and infrastructure investment carried the Chinese economy for years and both were well-functioning stimulus taps that could be turned on easily to smooth a downturn. These vehicles are fundamentally impaired now. Housing requires a lengthy period of real price declines to restore affordability and to work through inventory. During this period construction will be lower by necessity. The pace of infrastructure development simply needs to slow to reflect the stock. Over the past 2 decades, China has advanced to a position where it boasts some world-leading modern infrastructure. Further capital investments there will be ever less efficient. The rapid development has affected intertemporal transfers and the pace will have undoubtedly delivered many projects which will become a drag on the regions they are in. In an attempt to replace some of the output from these growth engines, China turned back to manufacturing and has successfully developed world-leading capacity in high-value exports such as EVs. However, this source of growth already looks impaired, some industries are hitting demand constraints and speeding along trade wars with the West. All considered, it’s hard to be constructive on Chinese growth for the foreseeable future.  Due to these faltering policy levers, we can’t even get optimistic about stimulus-induced upswings as we have in the past. Below you can see the negative real estate contribution to GDP and Fixed asset investment (orange line).

To monitor the progress of the China growth factor we can monitor the evolution of consensus forecasts and their drivers. As you can see from the below – growth is expected to fall below 5% this year and to 4.5% in 2025. 2024 expectations have risen somewhat since the start of the year. On the inflation front you can see expectations for this year and next declining steadily.

The trajectory for China's growth forecasts has been fairly flat this year after downgrades last year. This axis doesn’t look particularly dynamic at present without access to such effective policy tools the chances of game-changing stimulus look low.

The Greenback.

H1 this year began with 7 fed cuts priced by the market after a soft run for inflation in Q4 last year. Q1 turned that trend sharply into reverse with sticky ‘last-mile’ inflation concerns which briefly turned to fears of a reacceleration. Q2 inflation data came in softer, with some signs of weakness in the labour market emerging of late.

The pandemic gave way to highly unusual business cycle dynamics making it difficult for economists to gain conviction on the outlook. For example, there has been an unusually large divergence between goods and services demand. The hiking cycle in the US and the structure of the mortgage market have had the effect of freezing the housing market. Labour mobility is impaired and the goods purchases that often coincide with moving house are not occurring to the same extent. This consumption instead is transferred to services, exacerbating this divergence.

The best we can do here is follow the narrative for plausible trends and monitor pricing, data and the evolution of forecasts. As you can see in the above trackers, 2024 US growth forecasts have risen substantially since Q4 last year. 2024 inflation forecasts also rose in response to the Q1 data and have begun to moderate late in the past month. Based on the most recent data, US growth and inflation risks look skewed to the downside.

Bear Market for EM Flows

The Dragon-Greenback squeeze has contributed to a bear market for EM flows. The appeal of generic EM local bond performance has suffered from material allocations to low-yielding bonds in Asian markets such as China and Thailand, this depresses the overall yield especially when compared to an elevated US risk-free rate.

On the Equity side, the AI-led tech boom has helped crowd out other equity markets. The share of the US within MSCI World has been driven up to 70%, with each of the US Mega caps around 5%. This ‘US mega-cap exceptionalism’ has been part of a trend that has driven non-tech EM stocks to strikingly cheap valuations. Below we see the underperformance of the Brazilian index vs the tech-heavy Taiwanese index and the Nasdaq.

Goldilocks on-Goldilocks off

Up until the recent bought of EM weakness the rhythm of performance was dictated by a Goldilocks on-Goldilocks off (GOGO) factor. Strong activity and upside inflation prints took us beyond the comfort zone of markets in April, weaker growth and rising recession risks could take us to the other side of the equation. The dark scenario for EM assets would be a stagflationary outcome, which has remained sufficiently discounted all the time US growth has been robust. These fears might become more tangible as growth slows.

Low Vol and the EM Carry trade

Market volatility is a key mechanism through which the GOGO factor affects EM asset prices. “Goldilocks-On” depresses volatility thereby improving the vol-adjusted carry available to investors. This recent period of goldilocks-on has been positive for EM credit for much of the year so far and has laid the foundations for an EM FX Carry trade. As we have seen recently, as sharp rise in vol does significant damage.

In the charts below, you can observe that the level of EM FX yields over USD yields are not at especially attractive levels, however, the carry differential between EM high-yielders and low-yielders is notable. It’s not as striking as at the beginning of 2023, but is still elevated, and attractive in an environment of low volatility.

There have been two main approaches to carry trading in EM FX this year. The first is the basket/EM pair trading approach, which has been recommended in these notes (and elsewhere). The second is to find less correlated sources of FX carry in places where the yields vs USD are high in absolute terms. Two favoured examples are Turkey and Egypt.

Examining the basket approach we can see that 2022/2023 saw the best returns for this strategy. 2024 has been more challenging, relying more on the carry for total returns for much of H1 and recently experiencing a significant drawdown. One of the issues with the 2022/2023 phenomenon is that many of the higher carry currencies became more expensive as the lower carry currencies cheapened. These valuation mismatches create vulnerabilities to the trade and increase the risks of deeper corrections. One can avoid the most overvalued candidates when constructing a basket, and indeed I did so in the case of the Mexican Peso – as noted at the start of the year. An absence of MXN exposure in the recent episode of volatility was certainly an advantage.

These carry strategies are deployed partly in default of anything better to do in EMFX. Simply shorting the low-yielding Asian currencies has been a superior sharp ratio trade until recently, although many of these currencies became cheap adding fuel to the recent correction. Holding USD shorts dampens the USD volatility, but introduces more exposure to the GOGO. Additionally, it requires one to have a basket of high-yielders, and it is difficult to avoid either expensive currencies, currencies with poor fiscal positions, or both.

Fiscal Woes in Emerging Markets

Global government debt levels have been significantly impacted by the pandemic and energy price shocks. Emerging Market (EM) governments faced substantial deficits, first to support their populations and economies during prolonged lockdowns, and then to shield consumers and businesses from surging energy prices. This situation has been exacerbated by high global and domestic interest rates, increasing the cost of servicing the newly accrued debt. As more budget resources are diverted to interest payments, essential spending is being crowded out, further straining public finances.

Looking ahead, transitioning to greener energy sources presents another major fiscal challenge. The necessary investments are substantial, and many EMs are already struggling to secure the required funding due to their weakened fiscal positions. Additionally, the rise of populism has led to increased social spending as governments attempt to appease their electorates and fend off more radical populist challengers. This trend is evident not only in fringe political movements but also in mainstream parties, leading to broader fiscal indiscipline.

We can monitor the evolution of forecasts for major EM budget balances to identify where expectations are deteriorating or improving. However, determining market sensitivity to fiscal slippage, or failure to legislate for improvements, is more challenging. The expectations data may not be sufficient for a rigorous study, so we must read between the lines and watch for asset price underperformance relative to peers. Brazil serves as a case study this year. Despite only minor forecast deterioration, the market punished the currency to an extent that seems disproportionate to other factors.

Stronger External Balances

Recent years have seen significant improvements in the external balances of many EMs, unlike during the 'Fragile Five' era of the taper tantrum. Countries previously reliant on external debt have stabilized their accounts, supported by steady foreign direct investment flows. Higher commodity prices have bolstered export revenues, particularly for commodity-exporting nations. Strategic resource management and new trade agreements have also enhanced current account positions. As seen in the chart below, India, South Africa, Brazil, Indonesia, and Turkey now appear less fragile.

Political Analysis

The significance of politics in EM markets has increased. 2024 is a pivotal year, with recent elections in India, Mexico, and South Africa delivering varying surprises. This has triggered recent EM asset weakness, particularly the dramatic selloff in the MXN following Claudia Sheinbaum’s higher-than-expected victory margin in Mexico, raising concerns about aggressive leftist policies. For EM macro traders, understanding local politics is now crucial, adding complexity as traders must process both economic data and political shifts that influence market dynamics. While economic data can be efficiently condensed and analysed, following politics remains labour-intensive.

FX as a Limiting Factor for EM Central Bank Easing Cycles

The substantial Fed easing cycle priced out in Q1, coupled with ongoing EM central bank easing, has compressed rate differentials to pre-pandemic levels. This has left some EM central banks constrained by Fed policy. The challenging environment for holding EM assets makes EM central banks cautious about the impact of portfolio flows when setting policy. The deferral of the Fed’s easing cycle has caused many EM central banks to adjust their easing expectations. In some cases, central banks continued easing based on domestic factors, compressing spreads beyond market comfort levels, leading to significant currency underperformance, as seen in Chile and Czechia. In Brazil, FX weakness influenced market pricing away from easing altogether.

Currency Selection

Currency selection is driven by factors such as carry levels, vol-adjusted carry, ex-ante real rates, current account balance changes, growth, inflation, commodity terms of trade, and valuation. While these can be monitored, movements often rely on changes in expectations and narratives about these variables. A model monitoring these produces blended and disaggregated scores, with key variables highlighted below.

Ex-Ante Real Rates

Ex-ante real rates and their trajectory have been a good source of alpha recently, especially with Brazil’s recent rates selloff enhancing its appeal.

Valuation

For valuation, I default to the Real Effective Exchange Rate (REER) vs. its history. Although more sophisticated methods involving productivity adjustments or unit labour costs might offer improvements, simplified REER tracking remains useful. I do look at a range of BEER and FEER models produced by banks and research houses to give a blended impression, but I’m happy with historical REER for a single reference point.

Carry

One can look at simple carry, carry-to-vol ratios and the structure across multiple tenors. To include tail hedging costs, factoring in the skew, one can look at carry adjusted for 10delta USD (or EUR) call volatility.

IIF CEE trip

Lastly, I want to discuss a recent trip to Budapest, Warsaw, and Prague. For anyone who isn’t familiar with the IIF, they act as a link between the private sector and the official sector and produce excellent research for anyone focused on emerging markets, along with some capital flow data. I was lucky enough to join one of their regular investor trips to the CEE region, including the opportunity to speak on their panel at a regional central bank conference.

CEE FX has been a profitable vehicle for carry trading over the past year, and as a result none of the currencies of the countries I visited are cheap. All three countries have very challenging demographics that result in structurally tight labour markets. This is offset to varying degrees by immigration flows, but that leaves them vulnerable to swings in migration trends. From a political perspective, we have Poland moving on from a period of populism, Czechia potentially moving towards a period of populism, and Hungary likely to remain unchanged. The fiscal situation in all three is challenging with increasing energy transition costs and higher defence spending. Czechia seems to be the only one of the three where that challenge is met with caution – at least for now.

Poland has the most compelling flow picture and the most compelling growth dynamics. A new government will be deploying substantial EU funds over the coming years and these flows, both the RFF (post-COVID) and cohesion funds. These flows should support PLN and I have been keen to buy PLN on any position washouts.

HUF and CZK investing seems to also be a range trading exercise with both central banks dovish but cognizant of providing investors with enough real rates coverage to maintain currency stability. This naturally leads to mean reversion as policy drives FX then FX elicits policy tweaks.

I highly recommend the IIF and I look forward to future trips.

Share

Signing off…

Thank you for your time and attention. Please feel free to reach out with any feedback. As mentioned earlier, these notes will be infrequent but I look forward to checking in periodically.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

12^th Jan 2024

Personal Update

This is my first EMFX macro note for many months. In the second half of 2023, I joined Argo Capital Management, which is an EM-focused Hedge Fund. With their consent, I will write occasional personal views on the market. Argo invests in a range of EM assets from liquid macro-driven EM investments, such as those I discuss in these notes, to distressed debt. In past organisations, I’ve typically been the EM-focused member of a Macro business. Here at Argo, I’m on the more liquid-macro side of an EM business. I look forward to the experience.

Subscribe now

This note contains:

• Brief H2 2023 review

• Early thoughts on 2024

• Current trading views

• Thoughts on Turkey

• Updated monitors

Brief H2 2023 review

Given the time since my last note, I'll touch on the biggest moves from the intervening period. In my late summer notes, I talked about a more challenging H2 with the presence of easing EM central banks and a deteriorating growth outlook in China. As Q3 progressed, dynamics in US fixed income began to produce a considerable headwind for EM assets. Growing budget deficits, the absence of a clear end to the Fed tightening cycle, alongside a heavily inverted yield curve led to a sharp repricing of US term premium. Rapidly rising US 10-year yields came alongside a strengthening US dollar and provided a toxic mix for EM currencies. Signs that the US unemployment rate had troughed, along with some better news on US inflation towards the end of the year culminated in the Fed calling time on the hiking cycle at the December FOMC. EMFX recovered along with risk assets more broadly.

Above left you can see the selloff in 5y5y forward rates in the US alongside the move in the DXY. On the right, you can see the evolution of consensus forecasts for US inflation. There you can observe the increase in economists’ estimates for future quarters’ inflation rising in Q3 in the run-up to and during the term premium spike, then falling thereafter. Part of the reversal in expectations for inflation was due to the extent of rapid tightening of financial conditions, and a belief that these feed through quickly to the real economy.

Below is the performance of the trade-weighted index for each country in 2023 – data from the BIS.

In Asia, several central banks were forced into more hawkish policy stances due to rising US term premium, with some countries hiking to cover the risks of more pronounced depreciation pressures. One of these, Indonesia, was a popular destination for foreign bond flows and suffered more than most from the duration selloff as a result.

In CEEMEA, PLN began outperforming HUF once the Hungarian easing cycle began, with Poland getting a further boost from a market-friendly election outcome late in the year. Weak fundamentals continue to weigh on ZAR, but relative performance improved in H2. As other central banks began easing South Africa was forced to keep real rates higher, and this provided some level of support.

2023 was the year of LatAm currencies although by the end it was just COP, BRL, and MXN that delivered significant returns. The BRL NEER jumped in early December after a significant devaluation in Argentina. ARS still has a material (~8%) weighting in the broad BRL TWI. For our trading purposes, this is more of a distortion to discount.

Early thoughts on 2024

Starting a new year of trading is full of artificial constructs that are imposed by the calendar.  One of which is the P&L clean slate, which is usually asymmetrically skewed towards a negative dynamic.  If a prior year was positive, as 2023 was for many, then the cold reality of zero P&L cushion might be psychologically difficult. If last year was negative then the slate rarely feels truly clean, and drawdowns are often resilient to the calendar.  Just as Christmas can cause an overindulgence in food and wine, there is also an excess of views and market commentary supplied in the run-up to the holidays, and this can lead to an anchoring of views that isn’t necessarily merited by the information set. Additionally, a consensus or trend can be allowed to overshoot into the end of a year when it has a performance cushion. This year, that consensus is the US Goldilocks narrative.

At the start of 2024, EMFX moves are still highly dependent on expectations of the Fed cycle, as you’ll see from my correlation monitor later. Many EM central banks have already begun their cutting cycles and some are well into the process. This EM easing eroded the available carry in H2 last year and in so doing exposed local currencies to some adverse moves. In turn, expectations of easing from the Fed widens the interest rate differential, helping support EM currencies. Should a significant Fed easing cycle emerge this should soften the USD and strengthen EMFX broadly. Local currency strength would feed through to both lower inflation pressures, and a greater capacity for a local central bank to ease. How each EM central bank chooses to react to any currency tailwind will have a bearing on relative currency performance. Where growth is weak, EMs will likely embrace the opportunity to lower rates more than the market currently anticipates. Many EM central banks are already explicitly rebuilding their FX reserves, and this is another key dynamic to watch in currency selection.

Much like last year, there are 2-sided risks to EMFX performance from evolving DM growth/inflation dynamics. Should growth disappoint significantly, recession risks will give a bid to the USD and we can expect weakness in EMFX, if only initially. Should headwinds emerge to the global disinflation process, then we can also expect turbulence in EMFX. This could be a similar process to Q3 2023, or something more enduring.

At this juncture, I feel a resurrection of fears over sticky inflation seems the more likely. This is particularly the case in the wake of the significant easing in US financial conditions we saw in late 2023. This easing should boost growth, temporarily diminishing the recessionary side of the risk distribution. Economists have frequently cautioned that the last phase of the disinflation process would be the hardest, and that’s something we’ll have to go through in 2024. To me, there is certainly scope for an uncomfortable extended bounce or plateauing in core inflation in the US, which could easily spook markets away from Goldilocks. Additionally, the potential for price-related spikes in headline inflation looks to be on the table for some time given the evolving geopolitical situation in the Middle East.

Whilst there’s scope for caution, the Goldilocks scenario is the base case, and with good entry points 2024 can be a profitable year for EMFX. In prior notes, I mentioned the relationship EMFX has with Risk Parity, as EM local currencies benefit from both risk appetite and demand for fixed income. The recent Fed Pivot would seem to raise the appeal of risk parity strategies, as a freshly pivoted Fed can be expected to react more responsively to negative growth shocks or sharp increases in financial conditions. The strike on the famous Fed put should be closer to the money – and this should be constructive for EMFX. I have been bullish on this dynamic since the start of last year, and personally long EM local bond funds, but these investments are yet to gain the level of broad subscription I had expected. Despite some encouraging performance, the flows into EM as an asset class have been tepid at best. Perhaps 2024 will see some more momentum build.

Current trading views

From a tactical perspective, I feel the current consensus may be oversubscribed compared with the information, and am cautious about owning too much risk accordingly. More compelling risk-reward opportunities than those that present today may be available soon, and I would rather be in a position to embrace them.

Medium term I still like the higher carry, higher ex-ante real rates currencies within EM. Screening for countries with better growth dynamics will be more important than earlier in the cycle. As inflation steps down, growth will play a larger role in driving FX (as described earlier). 

Since returning to markets full-time, I’ve enjoyed working with the consensus forecast series available on Bloomberg. For FX I think the momentum of growth revisions and ex-ante real rates revisions provides a useful screen. Additionally, I like to look at the momentum in commodity terms of trade. Here is a flavour of the current state of play. I may go into greater depth on the use of these metrics in a future note.

From an ex-ante real rates perspective, levels matter and they continue to be a vital input to currency selection.

The above metrics and others lead me to favour Hungary within CEE, and Brazil and Colombia within LatAm. Asia looks like it’s mainly a destination to find shorts, with China, Taiwan, Malaysia and Thailand good candidates. India is the only currency in EM Asia that screens as a long. 

I like the idea of beginning the year with some long EM risk against the EUR, to eliminate some of the big USD noise, pick up more carry, and also benefit from any pivot coming from the ECB. INR looks like a convenient vehicle, where I can see the appeal of the carry and the potential for bond inflows post index-inclusion. Reserve accumulation will continue to be a headwind to really exciting performance in that cross, but it looks attractive nonetheless.

At this stage of the recovery in EMFX, it’s worth having some eye now on value. In the case of MXN, I’d be inclined to be neutral or trade from the short side in light of the substantial real appreciation in recent years. BRL, by comparison, looks like a trade where it’s easier to see the potential upside.

In Asia, I remain structurally bearish on China. Last year I wrote several times on how I believe China’s growth model has hit the buffers and I don’t have much to add to that narrative. I still like being short CNH, both against high carry EM FX, but also against the JPY. Japanese policy is out of sync with most of the world, and there is scope for a correction lower in USDJPY over the course of the year.  To avoid some of the negative carry, and to express my bearishness on China, I like being short the CNHJPY cross on a longer run horizon.

My preference remains trading carry in EMFX through RV trades (buying the high yielders vs the low yielders). In the same spirit, I now track the carry on the 3rd-5th highest yielders and 3rd-5th lowest yielders at any given point (from a set of 20 pairs).

As you can see the net carry declined from mid last year as policy easing began in EM.  The absolute level, however, still looks elevated. This is mainly due to the depressed yields on many Asian currencies. As a result, I still like periodic exposure to EMFX relative carry.

Thoughts on Turkey

Back on the radar for EMFX traders – too soon to engage?

2024 is a year where many are already talking about the exceptional levels of carry available in TRY.  Indeed, it screens even better when looking at Carry/Vol metrics. However, this is where the positive side of the story ends for me (for now). Real rates are still negative as are ex-ante real rates for 2024. The latter are so negative I have to exclude TRY from my chart.

Project credibility is going reasonably well in Turkey but scepticism remains over the long-term conviction to stick with the current level of orthodoxy. There are early signs of rebuilding net FX reserves, but they’re still negative on generally agreed-upon methods. Most importantly for the FX trade is that the currency is being guided weaker mainly in line with the forwards. This represents some real appreciation but the small gap between the forwards and an extrapolation of the current trend leaves only modest scope for pick up. There is some, but I would argue that it doesn’t currently compensate one for the asymmetric risk around the success or enduring nature of the current policy. There is both a risk that the current expected policy tightening won’t be sufficient and a risk that policymakers are once again leaned upon in a way that prevents the economy from receiving the medicine it requires. Nonetheless, TRY is back in play, and there may be opportunities to trade both sides as the story unfolds. The 12m Forwards look to offer a tradable combination of FX and rates, and I’ll be looking more closely at the edges of the range in the 12m FX Forward implied yields.

Share

Monitors

These are similar to what I’ve presented in the past and for a similar function. For more explanation of their use - see earlier issues.

Correlation

Looking at the evolution of EMFX correlations it looks like we are beginning to exit the most intense phase of a single driver trading environment. The US cycle will still be hugely influential, but there are signs that there is more scope for dispersion and idiosyncratic trades.

Trend

MXN, a popular long position of mine from H1 2023, has still been leading the pack in this recovery phase after the US term premium shocks of H2 last year.

Carry/Vol

LatAm and CEEMEA are still strong sources of carry with the basic structure unchanged from last year. There is probably scope to add a skew measure to this monitor and a smile component - so watch this space.

Leave a comment

Signing off…

Thanks for your time and attention reading this update, please feel free to reach out with any feedback. As mentioned earlier, these notes will be infrequent but look forward to checking in periodically throughout the year.

As always, if you’re trading, be disciplined and be lucky.

Stephen

Disclaimer

The contents of this note, including any analysis, opinions, and commentary, are purely for informational purposes and reflect solely the personal views of the author, Stephen Elgie, at the time of writing. They should not be construed as investment advice nor as an inducement, recommendation or solicitation to engage in any form of currency trading or other investment activities.

All information, data, and material presented in this note are believed to be accurate and reliable, yet they are not to be taken as a guarantee of future performance. The views expressed herein are subject to change without notice.

Readers are urged to exercise their own judgment and due diligence before making any investment decisions. The author and his employer, Argo Capital Management Limited accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material.

This note is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

25th August 2023

Subscribe now

In this note, I discuss:

• EM FX in a negative global backdrop, tactical longs only

• Recent macro developments

• BRICS conference – Opportunism, obfuscation, and opposition to the US.

• China – adjusting to a new normal

• Monitors

Share

EM FX in a negative global backdrop, tactical longs only

High rates in the US, and weak growth in China – this is the opposite of what an EM FX bull would cheer for. I’ve been tactically long since the sharp selloff early in the month, as I mentioned in my last note, but there isn’t a strong fundamental underpinning of a bullish view, and I hope not to be too greedy in picking my exit point. I am still long HUF and BRL. The former has been much more lucrative than the latter. As you will note from the monitors at the end of the piece, EMFX trends are broadly negative, and most currencies’ returns are being dictated by the same broad market driver.

A recent bout of strength in the broad USD has been especially toxic for EM FX. Both the EUR and the USD have been relative outperformers of late, with volatility in EMFX and weakness in the lower-yielding Asian currencies, particularly the Japanese yen. Looking at the year as a whole so far, you can see the consistency of weakness of the manufacturing exporters in Asia. These have been excellent funding currencies. Despite recent weakness in CLP, the Latam bloc has been overwhelmingly the place to be invested, although a weak growth outlook in China undermines the investment case here too.

With much pessimism about China surely priced in the short run, and having already seen a sizable run-up in US real yields I choose to maintain my tactical longs. Levels of carry are still elevated even if below the highs of Q1, and relative carry in EMFX remains particularly interesting with the extent of regional divergence. In amongst the noise of the macro data, there remains the potential for waves of optimism over a goldilocks outcome for the US which will boost risk sentiment and likely deliver gains in EMFX carry. US growth is tracking strongly for Q3 according to the Atlanta Fed GDP now measure, which printed 5.9% yesterday. If disinflationary dynamics are supportive enough to keep the Fed on the sidelines, then a strong risk narrative can emerge. Whilst the impact of deflation in China might only have a modest impact on US inflation, the narrative of strong US growth and a China exporting disinflation might become tempting.

On the flip side, one must question if these diverging paths for the US and China might be the cause of some market destabilisation. Such a material shift might break some unidentified market dynamics that were working in the background. Were the China narrative to trigger significant market stress, the Fed theoretically has room to cut, but may be prevented from doing so by domestic inflationary dynamics. The base case for September seems to be a hawkish pause from the Fed. It sounds unsatisfactory to identify an environment as tactical rather than thematic. But I was happy to hold thematic trades in the first couple of quarters, and I was clear at the start of this one that things had deteriorated on multiple fronts.

Macro developments

The second half of the month is quieter on the data front. Since my last report, we had some material deterioration in the credit outlook for China with some record weak lending numbers.  Additionally, we had disappointments in Chinese Retail Sales and industrial production.

In Poland there was weak industrial data, adding to the soft growth picture for the region. Turkish consumer confidence fell sharply, which is ironically good news as it aligns with the intentions of recent monetary policy actions.

South African inflation came in below expectations in a boost for the SARB with core falling to 4.7% YoY. Today we saw a small bounce in the mid-month inflation reading for Brazil, with the YoY rate moving up to 4.24%

In the US, Retail Sales beat expectations with the control group rising 1% MoM. Initial claims were lower than expected yesterday at 230k below the 4-week average, which now stands at 236.75k

Central banks

Taking things chronologically, the PBOC cut the one-year MLF rate by 15bp to 2.5% and the 7-day reverse repo rate by 10bp to 1.8%. Rate cuts aren’t going to make a difference to the housing outlook, or much of anything else, but it’s a signal of intent at least. In Russia, the CBR hiked policy rates by 350bps in an emergency meeting in response to recent Rouble weakness. The BSP left rates unchanged at 6.25%. In Turkey, the CBRT hiked 750bp to 25%, finally capitulating on the more gradualist approach we’d seen at recent meetings. With previous hikes failing to have a sufficient impact on domestic demand, it’s difficult to forecast where rates will need to go in the near term. The Bank of Korea and The Bank of Indonesia both kept rates unchanged at 3.5% and 5.75% respectively.

Opportunism, obfuscation, and opposition to the US.

There is a BRICS conference going on which gives an opportunity to the media to do short segments about fanciful concepts like an alternative reserve currency and the idea that these countries might trust each other. Opportunism and opposition to American power have been sufficient to encourage China and India to obfuscate about the illegal war taking place in the Ukraine. I’ve listened to a lot of advocates speak about the ‘global south’ and the different values they espouse. Few are heading in a positive direction when it comes to wealth equality within their countries. Both India and China have questions to answer about inclusivity within their nations. The sincere and optimistic politics of Germany over the past few decades towards both Russia and China demonstrated a spirit of cooperation that would seem to be consistent with a different approach to that which ‘the global south’ criticises the US for. The Germans, who seem more committed than most to a more equitable and inclusive global economy, are now suffering for their approach. One wonders how next year’s summit will look under Russia’s presidency.

China – adjusting to a new normal

Recent deterioration in China’s data has been notable and optimism over a comprehensive policy response has receded. This naturally leaves the market to ponder the structural headwinds. Let’s quickly run through the recent data disappointments.

The latest manufacturing PMI saw a move into contractionary territory. In the S&P report (spglobal.com) the Caxin economist noted “The market has been lukewarm, with sluggish demand, and supply has shrunk in tandem. The readings for total new orders and output were the lowest since December and January… The gauge for new export orders plumbed the lowest since September.”

In these past 2 weeks alone we had disappointments in imports, retail sales, and crucially house prices. Lending data on the whole was notably weak with some record year-on-year lows. For a full rundown, I recommend the monthly chart pack published by Yardeni China Social Financing (yardeni.com).

In the medium term, what worries the market is that China may have reached the end of the road with its existing debt financing model. The housing market looks to have been stretched beyond breaking point, and infrastructure investment has likely moved well past the point of delivering productive assets. Most of my former hedge fund colleagues expected this moment to come much sooner. It seems pretty clear that the China growth model hit diminishing returns well before the pandemic. If I had told most of these China bears of the 2010s how long the regime would be able to keep things on the rails they would have laughed at me.  

It seems pretty clear that housing can’t be replaced as an engine of growth in any reasonable timeframe. Moreover, the transition to a more consumption-led economy is impossible in the face of such a large confidence hit. Property demand dynamics have already had to digest structural headwinds from slowing urbanisation rates and household formation. Demographic trends don’t seem easy to arrest either with the latest fertility data showing the rate dropped to a record low of 1.09 in 2022. WSJ

The negative confidence shock from housing joins a broader confidence hit from the brutal lockdowns experienced by the populations of major cities. A Lancet article states “China's lockdowns have had a huge human cost. This cost will continue to be paid in the future, with the shadow of mental ill-health adversely affecting China's culture and economy for years to come.” The Lancet. Another analysis concurs (nih.gov).

What are the implications of this pessimistic picture? As discussed earlier we might expect some degree of global disinflationary impulse. We might also reasonably fear some unintended consequences. If the regular credit-fuelled China growth upswings are to be a thing of the past, then we’ve potentially lost a source of stability. Combine this with the temporary absence of a Fed put, and we are surely more fragile to downside global growth shocks.

CNY

Since this is an FX strategy piece we should turn to the currency. Fundamentally the backdrop aligns well to maintain a structurally short bias toward the CNY. The carry of this short continues to be attractive, and over the medium term, a weaker CNY suits policy goals in China. However, there are reasons why one-way traffic is undesirable to the Chinese authorities. Despite the success of capital controls it would seem risky to incentivise outflows so explicitly to avoid a build-up of pressure on the system. To avoid excessive speculation by foreigners, it might be necessary to periodically strengthen the CNY, perhaps sharply, even if this goes against the usual desire for stability. You can see some of this counter-trend strength in the NEER performance chart below, where I show CNY underperforming the rest of the region on a trade-weighted basis.

As I’ve discussed in previous notes there’s no shortage of ammo available to manage the CNY. For starters, the current account surplus remains formidable despite some recent export weakness and an anticipated pick-up in the services deficit from the end of travel bans. Authorities have multiple mechanisms for engineering short-term strength. They can use the fix as a signalling mechanism for the market, encourage state bank flows, and use direct interventions.

In my April note, I estimated that official reserves represented only around half of the true stockpile of FX that resulted from cumulative trade flows. Below I have isolated some prominent items in the BoP. These show how the politically sensitive official reserves remained at a steady level whilst FX was allowed to accumulate in other areas such as net errors and omissions and other investment. I explain this more thoroughly in this note China and the Renminbi, an EM FX Macro perspective (substack.com)

To support this, I looked at data published by SAFE on foreign exchange transactions. By comparing customer settlements against the trade balance one can observe a divergence post 2015 which represents this accumulation of foreign currency by corporates. At the time I pulled the data this amounted to approximately USD2.5tr.

With significant bond market outflows already digested, it’s difficult to see the authorities losing control of the currency, nonetheless, I intend on actively trading it from the short side, as it’s one of the very few EM currencies one can have a structural view on at present.

Monitors

NEER performance

I thought I would make a more regular feature of reproducing the broad NEER series. It helps me track trends outside of the noise that can be created in the USD or EUR pairs.

Correlation

EMFX correlations are notably high, with just a few of the usual exceptions. High correlation with the USD TWI, COPPER, RISK and Treasuries suggest a market dominated by one principal driver. An unusually positive correlation between the EUR and USD TWI is notable too.  Among the currencies trading more idiosyncratically MXN and HUF are most interesting, as these are the ones with a tangible investment case.

Trend

Again, one-month trends are nearly all negative for EM FX, with KRW, TWD and PHP leading the way.

Leave a comment

Signing off…

Over the course of the UK summer holidays, I’m only publishing a note every other week. Thanks for your attention, please reach out with any thoughts you have on what I’ve written or what I should be focusing on.

As always, if you’re trading be disciplined and be lucky.

Stephen

Photo by Jeremy Bishop

Subscribe now

11^th August 2023

This week I talk about the following.

• Surfing the waves – the recent sell-off in EMFX brings opportunities

• August macro developments

• EM Central Banks

• BRL and HUF – value and carry

• Monitors

The post-pandemic macro backdrop lends itself nicely to bouts of mean reversion. The dispersion amongst interpretations of the current outlook is sufficiently wide, and the data is sufficiently volatile and difficult to interpret.

With the US data received in July swinging the pendulum towards goldilocks, I concluded the opening paragraph of my H2 outlook with “Is this as good as it’s going to get? I have a feeling it might be.” I suspected EMFX was fragile to swings in sentiment and so it proved. Since then, we’ve had a material retracement, and some of the better stories in EM gave patient investors an entry point. I added short EURHUF first, with a few false starts trying to pick the top, and then followed up by adding short USDBRL. I’ll comment briefly on my choices later in the note. I must stress that I don’t believe these are positions to hold onto for months. When sentiment seems more favourable, I plan to let them go and wait for the pendulum to swing once more.

Whilst we can have brief periods of data consistent with ‘goldilocks’ in the US, I don’t think there are many in the market that will have that scenario as their base case for the medium term. Although this is one of the stranger cycles, a recession-free return to the Fed’s inflation target has to be a mid-to-low probability outcome. It seems much more likely that the current sharp and significant hiking cycle by the Fed, after over a decade of very low rates eventually results in a material downturn. The idea the fed could calibrate things perfectly in the midst of such an unusual and opaque period sounds too much like wishful thinking from investors who are all too used to enjoying sitting long of risk assets. For EMFX, even a more optimistic US outcome still leaves the challenges associated with weakness in China and the Euro Area. Many EM currencies had also experienced large gains this year so far.

The selloff

A backup in treasury yields and a steepening of the US curve seem to have been the trigger for the EMFX weakness. The absurd trajectory of US borrowing led Fitch to downgrade the US sovereign rating from AAA to AA+. There’s no doubt that US political polarisation increases the likelihood of further debt ceiling stand-offs and works against a material rebalancing, and Fitch politely acknowledged this. An increase in treasury coupon auction sizes in the face of rich valuations were cited as fuel for the moves. This phenomenon of US real yields moving higher further out the curve with a well-anchored front end represents a move to higher expectations of a soft landing in the US. This is fine for EM bonds in theory, but after a strong rally, to see treasuries selling off is an unsettling dynamic. Especially with risk premia reduced and carry eroded in the runup.

From what I can observe, the first week of the month saw a selloff in treasury yields of 28bps, with a 2.6% selloff in SPX. Msci world sold off 2.8% and the vix spiked 3.85 points. The USD strengthened just 1.2% against the EUR. Below are what I calculate to be the peak impacts on EMFX.

There were a number of EM currencies that were depreciating into the selloff, such as CLP and HUF with both central banks already easing. These still experienced material moves on the week taking their multi-week sell-offs to around 9% and 6% respectively.

On the right-hand side, I show an approximation of the weekly move adjusted for implied vol. Sometimes this exercise can reveal popular trades and one might conclude that recent ZAR strength was speculative in nature. Long ZAR is rarely a long-term conviction trade, and positions are often washed out in poor liquidity.

This selloff invaded a narrative within EM FX that was focused on the start of easing cycles, and currency performance can’t be divorced from these cycles, with the large trade-weighted appreciation seen in H1 playing a role in the disinflation process.

Macro Data rundown

The Caixin Manufacturing PMI finally fell below 50, back to levels last seen in January. Elsewhere in Asia manufacturing was mixed with improvements in Korea, Indonesia and the Philippines.  In Latam, there was a strong improvement in Mexico and a modest improvement in Brazil. On the services side, Brazil was weaker than expected, with China coming in stronger.

The narrative around global manufacturing continues to be an expectation of improvements on the horizon. Since the latest set of Global PMIs didn’t provide the necessary consummation of that view, optimism will need to be rolled further out. Below are the EM elements of the grid that S&P produces.

There was no bounce in the US ISM Manufacturing survey, but there was an encouraging bounce in new orders.  ISM services were in line but with a notable rise in prices.

China lending data today looked soft with TSF significantly below expectations at CNY528.2bn.

On the trade side, Chinese imports surprised significantly to the downside for July after falling in June. Korean exports were weaker than expected but with stronger tech exports. This dynamic supported Taiwanese exports, which exceeded expectations for July. There was a bounce in preliminary imports in Turkey, reversing progress on the trade balance for now.

On the inflation front, China fell into statistical deflation as expected, with a 0.3% yoy decline. Against this was an upside surprise to Core. Inflation came in softer in Mexico and the Philippines, and much softer in Poland, potentially bringing the NBP into play for September. Hungarian inflation was in line with consensus. We had a strong reading in Chile, and a modest upside surprise in Brazil with the yoy moving to 3.99%

Key US data events were anticlimactic.  Last Friday, Non-farm payrolls were close to forecasts with slightly higher earnings, a slightly shorter workweek and a fall in the unemployment rate to 3.5%. Claims continue to be low, with the 4-week average printing 231k this week. Yesterday we got a CPI report, which helped cool expectations of a September hike from the Fed. Core came in at 0.2% on the month and 4.7% on the year. A couple of weeks ago we received the latest senior loan officers survey (federalreserve.gov) from the Fed which does show a persistence of tightening lending standards in Q2. There remains declining load demand, although the second derivative there turned positive.

EM Central Banks

Hot on the heels of a 100bp cut out of Chile, Brazil Cut by 50bps to 13.25%, more than was broadly expected, with a close 5-4 vote. As you can see from the FOCUS report below, expectations for the policy rate have declined by the same amount on the week all the way out to 2025. So, this surprise isn’t being interpreted as a dramatic shift in the size or pace of the easing cycle. Ex-ante real rates have been compressed by 25bps for 2024 and 2025, but still stand at around 5%, and remain among the most competitive in liquid EM.

While Latam central banks were easing, the Bank of Thailand hiked 25bps to 2.25% in what is expected to be the last of this cycle. Rates were left unchanged in Czech and Mexico and Colombia

In the coming weeks, we have the likely continuation of normalisation from the NBH in Hungary, further tightening in Turkey and no change from Korea and Indonesia.

BRL and HUF

As discussed in the introduction, I added tactical longs in HUF and BRL in the past weeks. HUF has long been top of the Vol/Carry ratios I watch and with such a substantial pullback I forced myself to stick to the plan and use weakness to capture some of the carry. I don’t think there is a strong value argument for HUF, but the fundamentals are stable, and given the size of the carry on offer, it’s not expensive.

Brazil is still fundamentally cheap from a longer-term perspective and ranks strongly for carry and ex-ante real rates.

BRL bulls have been pointing to the strong goods balance this year. Below I break down the current account dynamics and include a breakdown of the main components offsetting the goods surplus from a recent BCB report.

There’s also a positive BoP dynamic in Hungary, with the latest goods balance coming in at EUR 1.1 billion in May (ksh.hu). A recent central bank report illustrates the improvement in Q1, with weak domestic demand depressing imports and delivering gains to the trade balance. The chart on the left highlights just how impactful the energy crisis was.

Monitors

Correlation

Very little of the idiosyncratic has been in play this month by the looks of the correlations. The magnitude of response to the main driver of the past month varies, but nearly all EMFX responded somewhat.

Trend

The selloff has eliminated positive 1-month trends for all but the meagre trends in MYR and COP. Most of the 3-month trends have also turned negative at this point. This just shows how the time for patient accumulation of positive returns on long EMFX positions seems to be behind us. As always, the above excludes carry, and a red bar means a negative trend in the local currency.

Share

Signing off…

Over the course of the UK summer holidays, I’m only publishing a note every other week. Thanks for your attention, Please reach out with any thoughts you have on what I’ve written or what I should be focusing on.

As always, if you’re trading be disciplined and be lucky.

Stephen

28th July 2023

Subscribe now

After a strong H1 for Emerging market FX, I write this outlook seeing some of the strongest levels of the year. This is a mainly a US-driven phenomenon, as we’ve seen progress on the inflation front without the kind of weakness in growth that would raise recession risks – full goldilocks. Easing core inflation raises hopes that the Fed may not need to throttle growth to achieve its inflation mandate. Meanwhile, China bears have grounds for pessimism but are watching the policy response to the Q2 softening, expecting some level of short-term relief. Is this as good as it’s going to get? I have a feeling it might be.

Disinflation momentum will naturally wane, particularly in year-on-year terms as base effects from the energy spike fade. Base effects aren’t ever a surprise, but perhaps irrationally, they do colour sentiment. With a focus on services inflation, volatile items can easily throw a spanner in the works of Goldilocks even if the thesis is correct. In China, policy actions may disappoint, and sentiment could easily swing towards an excessive focus on structural issues. I remain constructive on EM FX in all the ways discussed ad nauseam this year, but I’m defensive and tactical in my trading for now with the aim of having ammunition to trade any accidents that the backdrop and high valuations leave us vulnerable to.

In this note, I touch on the following issues.

• Outlook for the broad USD

• China weakness

• Evolving EM policy expectations

• Theme performance and drivers

• TWI trends and drivers

• Updated market monitors

Before I go any further, I will briefly summarise the latest macro developments that occurred since my last note. If you’ve been living each one in HD, then skim through this section.

Share EM FX Macro

July’23 macro

Much has happened so far this month, so I’ll stick to the headlines as I see them. Given the volume of data, I will separate out developments from China and the US.

China

Caixin Manufacturing PMI was down slightly, hovering at 50.5, still stronger than the NBS PMI which was unchanged at 49. Inflation data came in soft with the yoy rate for June CPI moving to 0% with producer prices falling 5.4%.

There was a notable pick-up in the Chinese lending data in response to weakness in activity.  TSF increased 4.2tr yuan, over 1tr above expectations in a clear sign of monetary easing.

Chinese export data was soft with exports falling slightly in June, following the notably weak print in May. This comes despite the much-publicised successes of Chinese car manufacturers. On Monday 17^th we saw disappointments from the GDP data and retail sales. Set against this was some stronger industrial data.

US

Robust activity, solid labour market data and better news on inflation have been the story of the month. Yesterday, we had an upside surprise to Q2 GDP printing 2.4% annualised. On the employment side, initial claims printed 248k, 237k, 228k, and 221k this month with the 4-week average moving down to 233.75k. The ISM Services employment component was strong at 53.1. The payroll report was solid but unremarkable.

The CPI report on the 12^th delivered a softer picture with core inflation surprising to the downside, and the “super-core” measure flat on the month. US retail sales were weak at the headline level but saw an upside surprise to the control group.

The Fed hiked 25bps, as expected, and remains open to a further hike in September, with plenty of data in the intervening window.

S&P PMIs

Global PMI data at the beginning of this month was soft, with the S&P composite output index falling from 54.4 to 52.7. Within that, we had manufacturing falling further, and some moderation in the strength of services. The below charts, taken from the reports produced by S&P Global, show new orders falling in June, most notably in services, for the first time in a while. Together with that softness, we can see disinflation continuing through the price indices.

I’ve pulled out the relevant heatmaps for the EM economies I look at, and we can see Mexico and Indonesia bucking the global trend. These have been a useful guide of late for RV views in the more free-floating currencies, particularly in Asia, where they might have helped lead us towards IDR, PHP, and THB over KRW, MYR and TWD.

EM data

In Turkey, the trade balance narrowed with Turkish imports contracting as expected and as per the orthodox plan. Rate hikes and FX depreciation are presumably hitting domestic demand, with exports only down slightly. The trade balance in Brazil grew again, continuing the current supportive picture there. Taiwanese exports were weak, with the forward-looking export orders data also disappointing last week.  Trade data in Malaysia also came in soft. In Chile, weaker imports boosted the trade balance. A similar pattern was seen in Indonesia with a large fall in imports in June.

Inflation in the Philippines was slightly lower (5.4%yoy) as it was in Korea (2.7%). Turkish inflation also fell slightly to 38.21% yoy; some work to do there. Downside surprises also in Taiwan (1.75%), Chile (7.6%yoy, -0.2%mom), Czech (9.7%), and South Africa (5.4%yoy).  Mexican and Brazilian inflation was in line, as was the case in Poland and Malaysia. In India, inflation ticked up slightly (4.81% yoy). Inflation in Thailand also surprised to the upside.

Central Banks

Naturally, we had a lot of inaction from central banks over the period. Rates were left unchanged in Korea at 3.5%, in South Africa at 8.25%, in Malaysia at 3% and in Indonesia at 5.75%. In Turkey, we saw a 250bp rate hike, again disappointingly small for many forecasters. However, this cycle is not complete, and we will likely see further hikes this year combined with other forms of tightening.  We saw a 100bp hike out of Russia to 8.5%. In Hungary, the NBH delivered the third of their 100bp 1-day repo cuts in a continuation of the unwinding of the use of this rate as a policy tool.

H2 Outlook.

My view is that we’re in a mature phase of a constructive regime for EM FX, with various positive drivers either diminished or reversing. Conviction is always higher with hindsight, but objectively we can list fewer bullish drivers today than we could in January, and must be less bold accordingly. Nonetheless, most of the good stories remain positive on a relative basis. Changes in expected rate paths cause me to be relatively more positive on ZAR, and less so on CLP. The framework I laid out for trading Asian FX still seems solid, with BoP dynamics and carry the two major variables. The former has turned more supportive for KRW. TRY has moved from untouchable to uncompelling, and CEE looks like a good carry/vol prospect if you can get a defensible entry point.  

The USD

Let’s begin with the broad USD, which will be a critical driver for EM FX. My bias from the start of the year is that high valuations tip the scales in favour of the bears. The end of tightening looks further away than many expected it to at the start of the year, but recent data has been more encouraging on that front.

As I noted in January, the USD REER is elevated, and it remains so against its commodity terms of trade.

As we see above and below, the broad USD has trading counterparts’ currencies with diverging fortunes. The Mexican peso has seen a strong recovery of late. The Euro and the Canadian Dollar have seen modest appreciation over recent months. Against that, we have the depreciation of the Renminbi and the significant depreciation of the Japanese Yen.

The USD rises and falls with yields at the moment, with any theoretical boost from recession risks seemingly pushed further down the line.

Many fundamental drivers don’t look supportive of a high valuation with the current account deficit widening through the pandemic and little support on the productivity front.

The caveat I have given recently is that quantitative tightening in H2 should provide some support for the USD.

China

I wrote in detail about China in 2 notes earlier in the year. The first <China and the Renminbi> covers the main FX story, and a section within this second note <China addendum> which covers debt market flows and expected tourism flows. This analysis concluded that the trade surpluses would continue to cause foreign currency to accumulate, and the trend would be that incremental FX would sit outside official reserves. I see no incentive from a carry or policy perspective for onshore actors to change course, and Chinese bonds will continue to be unattractive to overseas investors.

As I outlined in the macro data run-down earlier, there’s no doubt that the boost from the end of Zero-covid has dissipated. In a recent Fitch report, they released a series of declining growth forecasts. They cautioned against expecting recent easing to deliver a significant boost to activity given the subdued level of consumer and business confidence.

The China growth model looks critically impaired after last year’s accidents in the real estate sector. Real estate plays an outsized role in the economy, playing a vital role in local government financing and providing significant employment. If the central government doesn’t adequately resuscitate this sector, then they’ll have a sluggish economy on their hands for the foreseeable future. However, using the central government balance sheet to restart a mechanism that has already led to potentially excessive levels of both quantity and prices is a risky proposition. I listened to Richard Koo on a popular podcast recently who made comparisons with Japan’s balance sheet recession. Naturally, he advocated a sustained fiscal boost and proposed directing this at housing. He claims to have been engaged by the Chinese government directly, so it’s worth taking note.  

Assuming the Chinese policy response remains measured, I would expect China to be a (currently) valuable source of disinflation for the rest of the world. I would also expect little to no retracement of the currency weakness we’ve seen this year. CNY should remain a funding currency for the foreseeable future, even if the bulk of the USDCNY rally is behind us.

Evolving EM central bank expectations.

EM Central banks behaved more conventionally in response to resurgent inflation in the aftermath of the pandemic and are now seeing the dividends of their orthodoxy. However, less attractive bond yields erode support for EMFX. This year, many EM economies have enjoyed the positive feedback loop of appreciating FX assisting the disinflation process. The positive macro backdrop and attractive valuations caused capital to flow into EM local bonds with much of it unhedged. From these levels of valuation, we have to be mindful that the mechanism can go into reverse. This could be triggered by an episode of risk aversion and come through the currency channel, or could come through disappointments on the inflation side and be driven through the fixed income channel. On the latter, we must watch food price inflation with risks around Ukrainian grain exports and a strong El Nino.

As we move forward through time, we draw closer to the start of easing cycles, which will erode the carry implied in the FX forwards. I managed to acquire some 1y1y forward time series to look back at the year so far.

Here we can see some convenient groupings of currencies emerge, which we can refer to as high yielders, mid yielders and low yielders. There looks to be little changing with the low yielders outside of a modest, but significant lowering of expectations for CNY rates. However, there has been movement elsewhere. The challenging macro picture in South Africa has led investors to anticipate higher rates, with ZAR looking like shifting towards the higher yielders. For me, this puts ZAR more firmly in play for trading from the long side. On the other side of the roster is Chile, which has already begun to underperform the region, and could easily become a popular regional funder.

Theme performance and drivers

Ex-ante real rates continues to be a rewarding theme, and we should continue to monitor their evolution. Below I look at these for the end of 2024. As I’ve said before, generating these ex-ante real rate estimates is a challenge with my level of data access, and this is my best estimate of how things stand.

In some cases, expectations of future real rates haven’t come down too much over the past quarter. Changes in policy expectations have reacted to declines in inflation data and moving expectations for future inflation. As I’ve shown before, Brazil is a good example and the central bank publishes useful data in the focus report. We are seeing modest declines in market expectations for 2024 inflation and the policy rate, but these don’t materially erode the expected real rate.

Despite strong performance and some potentially unattractive levels, I will still opportunistically invest in this theme, and use it to adjust my currency preferences.

TWI trends and drivers

If we look at the NEER series, we can see the dynamics that have been in play so far this year.

In LATAM, performance has tracked the MSCI World Total Return Equity index (MSCI World). CLP has recently diverged, perhaps the magnitude of expected easing is part of that decoupling.

There has been much greater dispersion in CEEMEA, even between CEE currencies, with HUF trading with MSCI world up until around the time policy normalisation began. Poland had a choppy start, and I was guilty of getting long too early, suffering some pain, and then committing the sin of taking profits too early as a result. This looks like a terrible waste of an excellent opportunity in Q2.

In Asia, the low yielders have proved to be excellent funding currencies for most of the year. The higher yielders have performed better (even on a spot basis), with Indonesia the standout. The reversal in fortunes for the Korean Won has been dramatic, in line with the recovery in the trade balance.

Monitors

Correlation

USD weakness has brought higher USD correlations with the USDTWI once again, highly correlated with USD/ASIA, particularly the lower yielders. EM is also trading with Equities. The exception to this regeme is CLP and CEE which are more idiosynchratic. USDZAR looks to be behaving like a more conventional USD/EM now, perhaps a sign that higher yields are providing more adequate compensation for the risks.

Trend

The outsized spot moves in TRY and COP rather dominate the trend analysis on the full table on the left-hand side above. If we look at the bars excluding these two, we see the 3-month depreciation trends in a number of Asian currencies have paused and slightly reversed in the presence of broad USD weakness. In the short run, ZAR has been the biggest beneficiary.

Carry/Vol.

HUF retains the highest vol-adjusted carry with post-devaluation TRY, the highest yielder, only in 5^th place on my preferred measure.

Share

Signing off…

Over the course of the UK school holidays, I’ll probably publish a note every other week. Thanks for your attention so far this year, Please reach out with any thoughts you have on what I’ve written or what I should be focusing on.

As always, if you’re trading be disciplined and be lucky.

Stephen

Photo by Erol Ahmed

Subscribe now

30^th June 2023

At the end of H1 and with some holiday time coming up I want to review this year so far, reflecting on earlier thesis, with the hope of gaining insight into which views are still valid and which have had their time. I’ll do that after a brief review of the past week's markets and macro.

Share EM FX Macro

Weekly review

It suits the purposes of this note that we’ve had a quiet week and we have. Investors are digesting a higher-for-longer outlook for DM rates, wrestling with the same mysteries that have been present for much of the year. Post-pandemic, post-energy-spike economic forecasting seems unusually difficult, particularly for advanced economies where the level of government intervention was so extreme and the impact on households so divergent. Somewhat in contrast, EM economies have a more conventional look where strong and timely central bank responses look to have been effective in the main and will begin to be unwound later this year. If I were at a fund, I would expect to be more active in EM rates than in most other areas. As it is, I remain very lightly invested at this juncture in EM FX Carry in the ways discussed in prior notes.

At the end of the month, we begin to get BoP data from EM economies.  We saw the normalisation of the Brazilian current account (lower) and a wider-than-expected trade deficit in Thailand. Taiwanese industrial production improved on the month which gives encouragement to hopes of a regional pick-up in manufacturing activity. We had an upside surprise from Mexican GDP data, and broadly in-line inflation data from Brazil. US initial claims came in lower after a run of higher prints, again muddying the picture. In China, we had the NBS PMIs. In May, the Manufacturing print was starkly lower than the Caxin equivalent, and the June reading bounced only 0.2 points to 49. The services measure fell 1.3 points to 53.2.

The supply of inactive EM central banks is sparse, with none meeting this week at the time of writing. In the coming days, we have meetings in Colombia, Poland and Malaysia where policy rates are expected to be unchanged in all three countries.

H1 review

At the start of the year, I laid out a thesis for the start of the year that was bullish on EM FX. This was based on a collection of contributing bullish views. I’m going to run through these, with some updated discussion and charts. Many of these are overlapping dynamics so excuse any repetition.

• Bearish view on an expensive USD

• Anticipation of the end of the US hiking cycle

• Bullish growth impulse from China

• Expectations for mean reversion in US fixed income and risk parity

• Hawkish EM Central Banks and High e-ante Real Rates

• Strong Carry, and high relative EM FX Carry

Bearish view on an expensive USD.  The USD had negative momentum at the start of the year on a journey from overvaluation. At the start of the year, I cited the overshoot compared with the US commodity terms of trade, the elevated REER, and the current account deficit below the post-GFC average.

The dollar had a choppy depreciation so far this year, with a more uncertain outlook for H2. USD is a mid-yielder within DM and despite pricing in some significant cuts at certain points this year, the Fed now looks more likely to be hiking than cutting in H2. Additionally, quantitative tightening lies ahead.

Anticipation of the end of the US hiking cycle. In January we looked close to the end of the cycle and were anticipating a pause from the fed. As you can see from the Fed Funds Chart (where price declines reflect higher rate expectations), sticky core inflation prints and a robust labour market saw expectations rise. A sharp repricing followed the collapse of SVB bank, but after some consolidation, we have normalised back towards the highs of implied rates. The US TWI which was weakening at the turn of the year recovered on stronger US data and fading recession risks, before declining as the market anticipated a Fed pause. Recent weakness from a soft CPI print and rising US claims doesn’t look like the start of a trend to me.

Bullish growth impulse from China. The end of the zero-Covid policy in China gave a strong boost to expectations of activity both within China and more broadly. There was always caution over the composition of growth as I noted at the time: With respect to the China recovery theme, it’s important to note potential shortcomings of analysis based on historical growth upswings. The historical relationships are dominated by episodes of stimulus-led growth in China, which were characterised by high levels of fixed asset investment. This type of growth was commodity-intensive and in turn, benefitted commodity exporters. The anticipated China upswing this year will be driven by excess savings and pent-up demand that has been artificially created by covid and the zero-covid policies.  As a result, consumption will be a relatively more significant component than in past upswings with potentially different investment consequences.  

The expected growth upswing duly delivered in China for Q1, but Q2 has looked considerably more mixed so far. Taken in aggregate H1 data has been strong, but the recent trajectory has been a significant concern for markets. The housing market in China, a source of strength for the last 2 decades will come under increasing focus as pent-up demand for services fades.

Despite current reservations, the combination of a strong growth impulse from China, and expectations of easier monetary policy ahead from the US was a reliable historical cue to be long EM assets which had benefited in the past from easing policy in the US and strengthening growth in China and Europe.

Expectations of mean reversion in US fixed income and risk parity.  As I wrote in my first note in January, the odds favoured a 2023 rebound in bonds and risk parity:

EM FX performance can be heavily influenced by portfolio flows. After a terrible couple of years for bonds more broadly, there is undoubtedly scope for inflows into the asset class.  Local EM bonds often perform like a hybrid version of risk parity, with the EM country risk premium combining with the duration side of the bet.  Risk parity has had a decline of historically notable size, so all else equal one should be expecting a rebound….Bonds have never had 3 consecutive down years, and 2021/22 was the first back-to-back decline since the 1950s.

We’ve seen some normalisation here, but this has yet to be a powerful driver of returns in EM FX so far in 2023.

Hawkish EM Central banks and e-ante Real Rates.

Central banks that had broadly hiked earlier and more aggressively than DM central banks were generally near the end of their cycles as 2023 began. These remain cautious despite disinflationary forces. Higher post-pandemic debt levels bring greater fragility necessitating higher real rates to maintain currency stability. I have written regularly about the theme of investing in the currencies of countries with the highest ex-ante real rates with these differing markedly from spot real rates. I still maintain this bias.

Carry, and relative EM FX Carry

We’ve watched carry in vol adjusted terms all year and below we see the setup going into H2. Despite the normalisation process underway in Hungary, vol adjusted carry is still the highest in liquid EM FX, with over 1% annualised carry per vol in the one month.

Tracking Themes

Carry and Ex-Ante Real Rates have been two of the themes I have attempted to track this year by building relative value indexes that I describe in an earlier note. As I mentioned at the time, the purpose is to have a time series to track the themes rather than to create an investable index. I exclude Turkey and Russia, as they pollute the thematic analysis excessively, despite frequently qualifying as longs. The indexes are reweighted monthly with 5 longs and 5 shorts for each theme. Below you can see the longer-term time series I populated, next to this year’s performance. This has been a historically fruitful phase for these themes, which must concern one as to the potential for a pullback.

Below we see the environment we have enjoyed in H1 with relative levels of EM FX Carry at 5-year highs only beginning to decline in recent weeks. This decline comes from policy action in Hungary, along with evolving policy expectations in Mexico, Brazil and Chile. I base this analysis on 3-month forward implied yields. The decline in carry along with the outsized recent returns should make us cautious heading into H2.

Value

Below we see how we stand on longer-term Real Effective Exchange Rates (REERs) and as discussed in the past I like to look at these vs trailing average levels. This measure of valuation implies room for the Brazilian Real to appreciate over the medium term, but CEE currencies look to have already strengthened significantly. The recent depreciation in Malaysia and Korea can persist, but one has to justify increasing levels of undervaluation which I find especially difficult in the case of Korea, for reasons discussed in my note some months ago. For China, historical manipulation makes these trailing-average-based analyses more dubious.

Correlation

We have been tracking correlations this year to identify switching narratives and changing dynamics.  If we look at H1 as a whole we see distinct themes, with Asian currencies and the rand correlating most with the USD TWI, and the higher carry FX correlating most with US equities.

Returns and Sharpe

All year we’ve been watching EM FX performance for trends that we might want to participate in or challenge.

In this high carry environment, we see the impact of the forwards on the total return, this is particularly notable for the Turkish lira with more than 100% of the carry-adjusted loss taking place post-election. The low realised vol in CNY makes the Sharpe ratio of long USDCNY similar to that of long USDTRY.

Share

Finally…

As we reflect on H1, please feel free to browse the bottom section of some of my previous notes where I cast a more medium-term eye. Archive - EM FX Macro (substack.com).

• In January I discussed Brazil, Chile, and the theme of Carry.

• In February I discussed South Africa, The US Dollar outlook, and the impact of Real Rates.

• In March I discussed South Korea and the theme of value.

• In April I discussed the IMF outlook, China, and the potential benefits of long BRLCNH.

• In May I discussed Asian FX, El Nino and Turkey

• In June so far, I’ve written a longer piece about the outlook for India.

I look forward to tackling some more countries and themes in the coming 6-months.

After publishing next week’s note on the outlook for H2, I’ll be taking some holiday time and might publish more sporadically over the UK school holidays. As discussed in past notes, the purpose of my writing is for me to re-engage with markets with the aim of finding a more lucrative outlet in time. Operating outside of the flow and with more limited tools is a useful exercise and I’m learning from it, but it has its frustrations. If you know anyone who is interested in facilitating my return to a fund or a bank, I’m all ears.

Leave a comment

Thanks for your attention so far this year, any engagement is welcome. As always, if you’re trading be disciplined and be lucky.

Stephen

23^rd Jun 2023

Subscribe now

In a relatively quiet week for macro developments, I take the opportunity to lay out some longer-term thoughts on India. If you’re only interested in India, please feel free to skip past the first section, where I recap the week in global macro and EM.

In today’s note:

1. Summary and outlook

2. Macro Data

3. Central banks

4. India – caught in an AI and Climate Change pincer movement?

5. Market monitors

Share

Summary and Outlook

Here in the UK, the Bank of England’s 50bp hike dominated news media output. The UK seems addicted to a good media misery-fest, as we seemingly do our best to enhance the narratives that lead to the coining of the term Great British Peso. The ‘pesification’ of the pound presumably played some role in the justification for Thursday’s hike. After many years trading EM FX, I know there’s nothing quite like positive carry to paper over the cracks of a bad domestic story. The BoE may already have gone too far, risking a severe recession here. There’s an increasing risk that other DM central banks could also slow their economies more than is necessary as they continue to feel politically vulnerable to high inflation and over-correct for their failure to predict war in Europe.

Despite being one of the higher yielders, the USD has been soft within developed markets this month. Last week’s softer-than-expected inflation print coupled with a run of higher claims numbers support this weakness as does a sense of longer-run overvaluation. Running against this is the weakness elsewhere, the likely resumption of the Fed hiking cycle and the upcoming tightening of USD liquidity.

EM FX has been largely consolidating since last week’s heavy calendar, as anticipated in last week’s note. Carry trends are still in place with Latin American currencies performing well, led recently by BRL. The other side of this coin is the persistent underperformance of most of the negative-carry Asian currencies led by CNY and MYR. Boringly, I retain my long-held positions long MXN and BRL and short CNH which continue to perform. As mentioned last week, these have been scaled back of late after strong performance, and with part of the initial narrative around China growth looking less secure. I go into a little more detail in last week’s note Post21

Macro data

Taiwanese Export beat expectations on Tuesday giving some encouragement for the global goods sector. In EM, downside inflation surprises are coming thick and fast with core inflation in South Africa falling to 5.2%.  Mid-month core inflation in Mexico also came in softer at 6.91% YoY.

US initial claims were once again elevated, and as each week passes without a correction lower, we should get increasingly confident that the labour market is in the process of rolling over.

In Turkey, we had the latest set of trade data with imports jumping and causing a widening of the trade deficit. Given recent policy actions I don’t expect this trend to continue. Foreign exchange reserves rose on the week in a modestly encouraging sign.

Central Banks

It certainly wasn’t a quiet week for EM central banks, although inaction dominated the slew of meetings. The exception, of course, was Turkey who are in such dire straits that hiking policy rates a full 650bps to 15% represented a disappointment to market expectations that forecast up to 1000bps more. This hike will be part of a gradual process, but in this first step they immediately handed ammunition to those sceptical about ‘project credibility’.

In contrast to developed market central banks, the majority of those in EM are on hold with likely easing ahead. In Brazil, the BCB left the Selic rate unchanged at 13.5% and Banxico in Mexico left rates unchanged at 11.5%. In Chile the CBC also left rates unchanged at 11.25%, they look likely to be the early mover of these three and could ease policy at the next meeting.

The Hungarian central bank continued the process of policy normalisation by easing its 1-day depo rate by another 100bps. The Czech National Bank left rates unchanged at 7%

In Indonesia and the Philippines, BI and BSP left policy rates unchanged at 5.75% and 6.25% respectively.

Share EM FX Macro

India – caught in an AI and Climate Change pincer movement?

In analysing India this week I’ve been moved to discuss a longer-term issue. The current medium-term narrative seems a bullish one, with many suggesting that this could be India’s century. With superior demographics and greater levels of freedom, many in the West are enthusiastic about the notion of China handing the growth baton to India in the coming decades. They’re right about the demographic trajectories for sure. According to the UN World Population Prospects, by around 2080 China could have only half the working-age population of India.

What China appears to have achieved economically in the past 2 decades is unequalled across the globe. From 2002 to 2022 per capita GDP in China has increased by over 10x, this is the largest rise of any of the 200 countries in the IMF World Economic Outlook and is more than 4x the average rise of those countries. India, an impressive 26^th out of 200 saw its per capita GDP rise by around 4x.

What I will argue in the next couple of sections, is that despite all India’s positive factors – demographics, education, love of Cricket – India faces a future where they are possibly the most exposed nation to the two biggest shocks we can currently foresee; AI and climate change.

Artificial Intelligence

It’s quite possible that the pace of AI development continues at such a pace as to transform human society beyond recognition. I was certainly arrested by the plausible path put forward in the following article What will GPT-2030 look like?. However, for the purposes of my analysis, I assume progress on a path of steady business adoption of the likely capabilities of recently developed models. To me, this means AI complementing existing workers in businesses to speed up clerical tasks, basic accountancy and audit, mid/low-level coding, customer services, multiple low-level legal functions as well as a host of marketing and journalistic tasks. Essentially my expectation would be that we materially reduce the requirement for human labour in many existing businesses. I would assert that more experienced workers will be retained to work with the AI and others will fall away. To me, the obvious impact would be a reversal in outsourcing trends both within countries and on a cross-country basis. The kinds of roles that have been undertaken on behalf of Western companies by workers in countries with lower unit labour costs, who can work within a strict framework and with minimal executive responsibility, look squarely in the crosshairs of the algorithms. The largest global beneficiary of the practise of cross-country services outsourcing is India, and this business is vital to the country’s economy as we will see below, in its balance of payments.

As you can see on the left-hand chart, India runs a structural current account deficit. This is comprised of a large goods deficit and a small deficit in primary income, partially offset by a services surplus and a surplus of secondary income. Within the offsets that can be seen from services and secondary income 2 components dominate. Within the services surplus is Telecommunications, computer and information services. This is largely the phenomenon we are familiar with of companies in advanced economies outsourcing services to India. Within secondary income, we see Financial corporations, nonfinancial corporations, households, and NPISHs. Within that, the dominant element is Personal transfers (Current transfers between resident and non-resident households). These are transfers from Indians living overseas and remitting earnings back to families.

In summary, Indian labour, undertaking work for foreign companies both at home and abroad is currently doing a respectable job at keeping the current account deficit at a manageable level. In a world where AI is taking jobs and reducing the need for many types of human labour, where will this leave the planet’s largest workforce?

Not everyone sees things this way. In the initial phase of AI development and implementation, the skills of the Indian workforce are seen by many as giving it a competitive advantage (indiatimes.com). This may be true in the near term, but I would postulate that we will see one part of the Indian workforce engaging in projects to make another part redundant. Of course, once the AI implementation teams have completed their task, they too may become victims of the technology, potentially helped along by protectionist policies in Western countries. There are already those concerned by the potential of this phenomenon. Mezha.Media.

Climate Change

Moving to the other known shock humankind is facing, I find far fewer dissenting opinions on the challenges facing India from climate change.

This recent academic article goes into detail on climate model outputs for India. (frontiersin.org). Their findings are that the temperature will increase steadily in future during all the seasons, with maximum warming of ~4–5°C by the end of the current century. They also note that future monsoon rains are expected to increase significantly over most parts of the Indian landmass.

When viewing such average temperature change projections, we must take two things into account.

1.      India already regularly records temperatures above the threshold of 35°C (wet bulb ambient air temperature) where the ability of the human body to regulate temperature is compromised, presenting a risk of serious ill health and death. (worldbank.org)

2.      Climate change is bringing increasing volatility around the trends, and when you push up the mean and variance what you experience is a dramatic rise in the frequency of record-high temperatures.

This paper about the 2022 heatwaves and resulting deaths suggests that such events are already 30 times more likely than in the past and rising. (worldweatherattribution.org)   They caution that rising temperatures from more intense and frequent heat waves will render coping mechanisms inadequate as conditions in some regions meet and exceed limits to human survivability.

A study on preparing India for extreme climate events (ceew.in) suggests that more than 75 per cent of Indian districts, which are home to over 638 million people, are extreme climate event hotspots. They produced the below charts showing areas at risk along with time-series showing the increasing frequency of events.

Whilst India is likely to be disproportionately a victim of climate change, it’s worth looking at how its own actions are viewed at this moment. The 2022 Environmental Performance Index (EPI) which I’ve used in prior reports ranks India 180^th out of the 180 countries they track. For climate policy, they are 165^th. Countries with lower GDP per capita tend to have a lower capacity to tackle many environmental issues, so we must compare India along these lines and against its regional peers.

Regrettably, India is underperforming however you view things. India has an index score of 18.9, which compares with regional peers Pakistan (24.6), and Sri Lanka (34.7) and with BRIC peers Brazil (43.6), Russia (37.5) and China (28.4). For greenhouse gas (GHG) emissions, it ranks as 3^rd highest as a proportion of GDP, behind the world’s largest consumer (USA) and the world’s largest manufacturer (China). This is a pretty shocking statistic for a country that is a heavy services exporter and goods importer.

On the energy front, the picture is equally troubling, with no discernable reduction in the proportion of fossil fuel use. Despite the positive anecdotes, the engagement with renewables looks seriously lagging.

Beyond Climate and AI

For a weekly EM FX strategy note this is all very long-term, and I feel compelled to return to my remit and run through the macro picture with an eye on the Rupee.

The near-term picture is of an economy which is growing at a good pace, with rapidly improving current account dynamics and a challenging but stable fiscal outlook. The process of disinflation is going well overall and relative to EM peers. A proactive central bank is likely to continue to keep the currency from appreciating.

As we saw earlier when looking at the BoP, the current account deficit (CAD) is below its medium-term average at present with the 2022 deficit the widest seen since 2012. However, the picture is improving, with Fitch recently cutting their estimate for the FY23 current account deficit to 2.3% of GDP from 3.3% in December. As we saw earlier its services exports are a key offset, and the near-term outlook looks positive with labour market tightness in advanced economies supporting outsourcing.  India is a large importer of energy and was impacted heavily by the global price rises resulting from the war in Ukraine but it has benefitted with others from price declines this year.

India uses foreign exchange intervention in times of INR demand to keep the country's exports competitive and helps ease their BoP weakness. The RBI has been rebuilding reserves into the USD downturn since November last year.

As we can see from the long-term chart above, India’s NEER has been steadily depreciating due to consistent inflation differentials with its major trading partners. However, the REER has been relatively stable because the nominal exchange rate (INR per USD, for instance) has been adjusting to offset the inflation differential. Looking at the REER, the currency sits above its long-term average but comfortably below recent highs.

According to S&P, output has been robust in 2023, with India’s PMIs some of the strongest in EM of late. Business activity registered 61.6 in May, which is as strong as it’s been in the history of the PMI series.

Inflation has moderated, particularly of late with a large drop in food prices helping YoY inflation move back towards the RBI’s target.

Fitch recently forecast India’s government debt/GDP ratio to stabilise at around 83% over the next five years. This level is high for its rating peers, with Fitch suggesting the government’s fiscal targets look challenging with high growth forecasts embedded into their forecasts. One key positive is the relatively large level of domestic financing of its debt.

Looking longer term we can see governance has improved under Modi, with improvements in the areas you might expect from an authoritarian shift. They are seeing progress in political stability no violence, regulatory quality and government effectiveness.

The Rupee

From the ‘market monitors’ section of the report, you will see recent USDINR market correlations show INR trading inversely to the USD, and in a similar way to many of the higher carry currencies of late. With its inferior level of carry it is trending more weakly than most of its peers with only modest trend strength. From a carry-to-vol perspective, it sits towards the bottom of the positive-carry EM currencies I track.

For interest’s sake, I looked at how the INR NEER has traded with the NEERs of its trading partners. Here we can see that the INR NEER has the most consistent correlation with Taiwan, Indonesia, and strangely Colombia. There has been no relationship of late with the EUR NEER

I haven’t recommended INR at any point so far this year mainly because there look to be better stories from a carry and value perspective both within the region and globally. Despite the positive macro-dynamics, the central bank is likely to continue to make the trade uninteresting. In future, I feel I am more likely to be involved on the short INR side on an RV basis.

Market Monitors

Correlation

The decoupling of much of the low-yielding USD/Asia pairs has evolved into a strong negative correlation. The exception continues to be USDKRW. 

Trend

What we’re seeing here is a volatile week rolling out of the 3-month window, improving the Sharpe of established 3-month trends.

Carry

With project credibility well underway I can include the lira in this analysis once more. Distortions in the forwards should diminish and we should get a clearer idea of the Carry/Vol tradeoff.

Share

Signing off

Thanks for taking the time to read this note. I publish weekly strategy notes with periodic deeper dives into pertinent topics. Any feedback or engagement is always welcome.

In the meantime, if you’re trading, be disciplined and be lucky,

Stephen

Photo by Federico Burgalassi

16Jun23

Subscribe now

This week I discuss:

• Strong reaction to benign outcomes

• Macro developments – US CPI, FOMC, China data

• EM Central Banks – little expected for most, a lot expected from Turkey

• Turkey Update – Project Credibility

• Market monitors

This week’s events were clearly sufficient to temporarily tip the balance in favour of the wall of EM FX Carry, as interpretations of the US inflation picture skewed dovish diminishing worries that sticky inflation would lead the Fed to become more aggressive. The reaction this week reflects cracks in the wall of worry that has been holding back investors of late. Also key to the moves is the calendar; this week had a lot of event risk, and next week has much less. As I wrote in my early Feb note, we can think of volatility as the likely impact of market-moving events that can happen in a given window of time. You get paid extra for selling vol through events, but you don’t get explicitly paid a higher yield on your carry trades. With the concentration of events this week, appealing medium-term carry trades suffer a brief decline in their implied carry-to-vol ratios. However, once the event risk passes without narrative shifting surprises, short-term implied carry-to-vol ratios rebound. It’s therefore reasonable to expect higher-yielding EMFX to be underpriced into an event and rally on a consensus outcome. So we received the dual boost this week with the negotiation of event risk in a manner that seemed to imply a reduction in tail risk. Happy days. Now we have seen the market reaction, is there anything that should lead us to chase these moves or should we be cautiously taking profits in anticipation of the next emerging set of worries? The latter is my bias in this environment.

Added to the reality that we’ve had a strong move for much of EM FX, we should still be digesting the deterioration in the fundamental case for the broad asset class that we discussed last week. Optimism towards China and Europe is diminished compared with Q1, and despite a brief period of weakness in the USD, it’s unclear that we have the ingredients for a protracted sell-off.

I retain the same set of medium-term views I’ve had for some time, that very strong levels of carry will keep EM FX attractive, and that we should be especially constructive on currencies with high ex-ante real rates, such as those we see in Latam and in Hungary. However, we have seen significant moves already this year and part of the Q1 bull case (Strong China/Euro Area) is under threat. On the positive side, the local picture in many of these high-carry currencies is playing out just as we would have hoped from the start of the year. Disinflation is well underway, yet central banks retain a level of cautious hawkishness. From a valuation perspective, currencies like the BRL still have a lot of potential to strengthen. My recent 3 core positions of long MXN and BRL and short CNH still all make fundamental sense, but tactically I’m cautious, and inclined to maintain some ammo.

Although the above excludes the last few days due to lags in the BIS data we can see the continuation of mean reversion in KRW and somewhat in ZAR.  I continue to exclude TRY from most of my monitors, but I’ll attempt to compensate with some commentary on Turkey later in the note.

Recent FX strength will increase the attractiveness of local rates markets that have been held back by the global sticky inflation phenomenon. There is a reasonable chance that a virtuous cycle can emerge here where local bond investors can enjoy the twin benefits of shifting policy expectations and currency strength. I maintain a structural long position in EM local bond ETFs.

Macro Developments

In a quiet week for EM data, DM events have been the principal drivers of EM FX returns this week. The key was US CPI, with goods deflation bringing down headline inflation, and signs from the PPI numbers that this will continue. The dovish expectation is that this will eventually feed through to service prices. 4% Core inflation looks like a dream to us in the UK, but for the Fed, it is still higher than what was implied by recent forecasts and is clearly double their long-term target. Doves were buoyed by the softness of the ‘super core’ measure, although even these attempts to produce a cleaner measure are subject to distortions.

There was little good news from the May credit report out of China. This was the second consecutive disappointing report after the bumper Q1. The PBoC has begun to respond by easing policy.

The ‘hawkish pause’ from the FOMC seemed to reflect expectations that credit stress is easing. Perhaps if they deliver another 2 hikes this summer, they can create some more…

The ECB followed up with a 25bp hike on Thursday with their own hawkish tilt.

Thursday brought more weak data from China with disappointments in retail sales, fixed asset investment and industrial production.

US Claims remained high this week at 262k moving the 4-week average up to 246.75k. Maybe more tangible evidence for the doves than much of what came before.

EM Central Banks

As expected, rates in Taiwan were left unchanged at 1.875%. Next week is a bumper week for the mainly inactive EM central banks. We will be looking for signs of dovishness from policy statements in Mexico and Brazil, where the on-hold Banxico and the BCB monitor the impact of their hiking cycles. Hungary can continue to normalise their interest rate structure following the successful commencement of that process last month. Indonesia and the Philippines are also likely to keep rates unchanged.

The real event of the week will be in Turkey, where ‘Project Credibility’ should see a change in policy from the central bank. The newswires are plastered with JPMorgan’s suggestion that rates may be hiked to 25% at the coming meeting.

Turkey – Project Credibility

Despite not trading the lira at present, I can’t avoid continuing to comment on developments in Turkey. After the heavily forecast post-election spike in USDTRY and the forwards, we have moved into a phase that I’m calling ‘Project Credibility’. This consists of appointing Mehmet Şimşek as finance minister and Hafize Gaye Erkan, as the governor of the Central Bank. Both have sufficient international credibility to give the appearance of a key shift in approach. This is expected to be followed up by a more orthodox monetary policy stance, which must begin this coming week.

In the history of Erdogan’s Turkey, this is not the first attempt to restore credibility in the face of market stress. There have been many occasions where orthodox appointments have been made and the central bank has been encouraged to look more independent. We know how all of those turned out. A powerful autocrat runs Turkey and has different views on how policy should be run, he is clearly prepared to tactically retreat and theoretically allow the economy to take some of the orthodox medicine it needs. This crisis is the worst yet, and he has a fresh mandate that won’t need renewing for some time. This might mean that project credibility will be in place for a little while. Certainly, long enough for those making expensive bets against the Lira to withdraw for a time. That’s presumably why we’ve found a modicum of stability. However, pivoting to more conventional policies, even in the absence of any scepticism over the longevity of the switch, is only the beginning of a painful journey. 25% rates may tempt some optimists who see a window to monetise the immediate FX impact of a policy shift.

This week we had balance-of-payments data for April and saw further deterioration in the current account. April’s deficit was recorded at USD 5.4 billion, down from USD 4.5 billion in March. Official reserve assets data for May fell to USD 97.1 billion from around USD 115 billion in April. This takes Reserves less FX loans and contingent liabilities into negative territory, notwithstanding the stock of FX derivatives. Let there be no doubt that the new governor inherits a currency crisis.

If rate hikes are large enough, Turkey should experience a contraction in aggregate demand sufficient to narrow the current account deficit. A significant period of currency stability will be required to repair the FX position of the central bank.

Naturally, a contraction is unhelpful for the country’s debt dynamics. As a reminder, Turkey’s stock of external debt is larger than that of many of its EM peers, which is a key feature of its current vulnerability.

As of the April report, the short-term external debt stock recorded USD 161.9 billion an increase of 8.6 per cent compared to the end of 2022.

I wrote about Turkey around a month ago here <Let’s talk Turkey> which gives some of the background to the current crisis.

Monitors

Correlation

The very recent USD weakness has come with a pickup in correlations between much of EM FX and the USD TWI. 2023 laggards KRW and ZAR are notable participants. Apart from the KRW rebound, low-yielding USD/ASIA has had a low to negative correlation with the USD. This decoupling has been an increasing theme of late, led by the relentless depreciation of the CNY.  The block of EM currencies in the middle of the grid from IDR to HUF, which represent high carry currencies is showing an unusually strong correlation with risk and copper. This has been heavily impacted by this week's strong moves.

Trend

This week, I thought it might be worth observing the weekly change in my trend indicators. For new readers, these are Sharpe-ratio-based indicators where +ve represents trend strength in the EM (local) currency. You can see the development of the stronger KRW trend, and the turnaround in ZAR. In Latam, the medium-term trends are still more powerful than those in the short run.

Carry

Only minor changes to the carry picture week on week. The structure we’ve become familiar with is still in place.

Share

Signing off

Thanks for taking the time to read this note. Other commitments have prevented me from delivering a deeper dive this week on any of the many interesting topics out there at present. Hopefully, next week will afford the opportunity.

As always, please share the note with anyone you feel might enjoy it.

In the meantime, if you’re trading, be disciplined and be lucky,

Stephen

Photo by Harold Mendoza

Subscribe now

9^th June 2023

This week I discuss:

• Loss of soft USD support for EMFX

• Updated Themes

• Updated EMFX performance including TWI performance.

• Highlights from the Global PMIs

• PIX system in Brazil

• Turkey Update

At the beginning of the year, we had a strong set of drivers for EM FX. Amongst those was the favourable relative trajectories of the EU, China and the US. We were nearing the end of the tightening cycle in the US, with growth in China and Europe expected to rebound strongly. As we stand today that constructive dynamic looks under threat from all 3 angles. Recent data out of China leaves concerns over the durability of the bounce observed in Q1, with similar concerns emanating out of the Euro Area. Following the end of the US debt ceiling charade, there is an active debate that any Fed pause could be short-lived, with patience potentially running thin over the sticky nature of core inflation and in the context of a robust labour market.

The recent broad recovery of the USD is a response to these dynamics and with quantitative tightening on the horizon it’s difficult to bet against some continuation.

Without a soft USD backdrop, EM FX trading is a relative game, and as I’ve been discussing all year there are some strong themes in that regard. Carry and ex-ante Real-Rates based themes have already delivered strong returns, with high-yielding Latam and CEEMEA currencies performing well, and low-yielding Asian currencies under pressure. My recent expression has been long MXN and BRL and short CNH. I’ve taken off most of these core positions in the near term, but I’ll continue to trade tactically in that direction. I mentioned 2 weeks ago that I would use the resolution of the debt ceiling to take profits on EM FX longs, as I anticipate some fears to re-emerge over the path of US disinflation. With so much relative strength already observed, I think it’s worth being patient.

Above (left) we can see the strong total returns of 3 themes. The right-hand chart shows how my expression of carry has performed against US equities, and against a risk parity measure. I expected risk parity to do well in 2023 after heavy losses in 2022, and that view remains a foundation of a medium-term constructive view on EM FX. A decline in US recession odds has occurred over the past month, and judging by equity performance, markets may judge this decline to be more meaningful that rising fears over further Fed tightening.

TWI performance

Periodically I review EM FX performance on a TWI basis as it has the potential to give clearer insights. Here you can most clearly see the recovery of the Korean Won, despite only tentative signs of recovery in exports. This could be mere mean reversion after such a sustained period of relative weakness, something I flagged some weeks back but shamefully failed to pull the trigger on. A similar dynamic is visible in the Taiwanese Dollar. It would be easy to imply significant optimism over tech exports, but as far as I can see, the jury is still out there.

Macro data notes

In China, we had conflicting signals from the PMIs. First, the NBS manufacturing PMI came in soft. This was followed by much stronger than expected Caixin PMI. This latter reading was strong enough to materially boost the global manufacturing picture in the S&P series. I’ll cover the global PMIs in their own section

In Brazil, headline CPI came in below expectations at .23% MoM, with core rising 0.37%. Disinflation looks on course there. The same can be said of Mexico, where headline inflation fell by .22% MoM, with core inflation rising slightly less than expected at .32%.

In the US, we had another solid yet mixed jobs report with the 339k headline surprising alongside upward revisions. There were falls in weekly hours and wages together with a rise in the unemployment rate to 3.7%

The most recent US initial claims print yesterday saw a jump to 261 raising the 4-week average to 237.25. With the multiple head fakes observed in employment data in recent months, most of us will wait for some reinforcement of this signal before reading too much into it.

Central Banks

In what should be the drumbeat of the summer, all but one EM central bank kept policy unchanged in recent meetings. The use of copy and paste was significant from the NBP in Poland, with rates set to remain at 6.75% for the foreseeable future. In India, the RBI kept rates at 6.5% despite recent encouraging inflation prints. Activity has been strong recently in India and the central bank did strike a hawkish tone. To buck the trend, the Bank of Thailand raised rates by a quarter point to 2%. They held back in recent months, to observe the evolution of the DM banking stress. They seem to view these risks to have passed.

Next week we have a meeting in Taiwan, where no change is expected.

S&P Global PMIs

These reports kick off each month and seem to be the best forward-looking indicator we get. I lifted the below charts from the reports that S&P posted on their website (spglobal.com). As we can see the global composite is strong and we still have the divergence between the goods and services sectors.

Services are still in a recovery phase from the pandemic which has created an unusually large divergence, certainly in the history of these series.

The global manufacturing print is heavily supported by a strong China number I discussed earlier.

Within the global composite, there is data that can give us insight into the inflation picture. The index for Input Prices fell from 58.5 to 56.7 and the index for Output Prices fell from 54.9 to 54.4. Measures of goods inflation are normalising, whilst services measures continue to be sticky.

S&P produce manufacturing PMIs for the majority of the countries I cover in these notes, and I’ve reconstructed the relevant elements of their heatmap.

As I mentioned a few weeks ago in my Asia focus piece (Asian FX Focus), these have given a good signal for EM FX RV.

Turkey FX

I wrote about Turkey in more detail between the rounds of the recent election. (Let’s talk Turkey).  As predicted in my pessimistic note, spot USDTRY has marched higher since the conclusion of the election. I don’t have visibility on liquidity, but judging from the FX forwards, I can only imagine the chaos. The passthrough from such rapid depreciation is going to further challenge the domestic inflation picture.

We don’t have the May data for reserves yet, so all we can do is reflect on the pre-election state of affairs, with a central bank effectively short USD in the midst of a currency crisis. Short of a full-scale epiphany by Erdogan I’m a seller of bounce in TRY on the back of a move to a more orthodox policy.

A note on PIX

At a recent event in London, an employee of Banco de Brasil showed me how the PIX instant payments system (bcb.gov.br) operates.  As in India with their successful Unified Payments Interface (UPI), the power of secure mobile banking that provides access for the previously unbanked is very powerful. There are benefits in crime reduction, productivity for banks who don’t need to drive as many armoured trucks around the country to fill up ATMS, and benefits to the tax revenues of digitising grey economy activities. My UK banking apps looked poor in comparison with what my Brazillian friend had at his fingertips. Using PIX, the simple scanning of a QR code does the bulk of the work in making an instant payment. Cryptocurrency bears will point to these systems as fulfilling one of the original use cases of Bitcoin, although those who crowdfunded a pro-Bolsonaro insurrection using PIX might be uncomfortable with the lack of anonymity.

Market Monitors

Correlation

KRW and TWD are diverging from broader USD/ASIA. EUR/CEE's historical correlation to the EURTWI has broken down of late. EUR/CEE can often be inversely correlated with the EURTWI, with strong EU macro developments driving local currency outperformance in CEE.

Trends

Carry currencies are maintaining some medium-term trend strength with COP the short-term stand out. Overall, short CNY vs the USD is still the strongest trend.

Carry

No major changes in the last few weeks. The post-NBH fall in HUF carry doesn't come close to taking it off the top spot.

Share

Signing off

Thanks for taking the time to read this note. These notes cover my personal thoughts on markets and macro from outside of the industry. Any thoughts and feedback from those closer to the action would be appreciated.

As always, please share the note with anyone you feel might enjoy it.

In the meantime, if you’re trading, be disciplined and be lucky,

Stephen