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EMERGING market (EM) currencies closed out their best year since 2017 after soaring in the final quarter as the outlook for lower interest rates in the US revived investor appetite for risk.
The MSCI gauge of currencies edged higher last Friday, the final trading day of a year in which it gained 4.8% against the dollar.
Hard-currency debt from developing countries posted its best returns in four years and emerging equities snapped a two-year losing streak.
The rally across asset classes shows how money managers rediscovered their taste for higher-yielding securities as slowing US inflation paved the way for lower borrowing costs and continued growth in the world’s largest economy.
The recovery pushed through even as a much-hyped Chinese economic rebound failed to materialise.
It’s “showing once again the power of lower US interest rates and a softening dollar,” said Hari Hariharan, chief executive officer at NWI Management. Though the rebound in emerging markets has been remarkable, it’s “clearly a non-China comeback.”
Developing world stocks posted a 6.9% gain, while the gauge that excludes companies from the world’s second-largest economy rallied over 20%. Debt denominated in local currency posted a 6.3% return, the best since 2020, while dollar debt has reaped an 11% return, the most in four years.
The cost of insuring exposure to EMs has also eased, with credit default swaps across 22 sovereign issuers sliding an average 72 basis points to levels last seen in September 2021. Still, EMs saw US$28.7bil in outflows in 2023, the second-consecutive annual loss, according to data compiled by JPMorgan Chase & Co.
Ricardo Adrogue, head of the global sovereign debt and currencies group at Barings LLC, said disinflation, growth and US monetary policy would remain the key themes for EMs in 2024.
“EM overall still offers value,” he said, “especially in a world where the dollar is likely to have peaked together with US interest rates.”
The greenback has lost nearly 3% this year, its steepest annual drop since 2020, amid bets the Federal Reserve will embrace monetary easing early in the coming year. That stands to weaken the US currency further in the coming months.
Still, Adrogue warned of geopolitical risks that could introduce volatility, including the possibly political comeback of former US president Donald Trump.
“There is no doubt that a win by president Trump will be globally disruptive,” he said. “The question is how disruptive.”
Below are some views on what next year may hold for EM:
> Forex: Latin American currencies were this year’s winners, led by the Colombian peso’s 25% advance against the dollar. Jason DeVito, senior portfolio manager at Federated Hermes, expects that regional outperformance to continue.
“We generally see strength in Latin America on strong commodity prices, potentially due to more stimulus from China, and continued success in the Latin American monetary regimes taming inflation.”
In general, central banks’ credibility remains intact across the developing world, which is helping to drive down risk premia, DeVito noted. While US rates should drive near-term gains, he said “maturing monetary and fiscal regimes globally should drive high returns in EM forex.”
> Bonds: Next year should bring bumper gains of as much as 10% in local-currency EM bonds, predicts Manik Narain, head of emerging market strategy at UBS.
“We see emerging markets in a favourable part of the disinflation cycle,” Narain said. While core inflation – stripping out energy and food prices – has not eased as quickly as in the United States, he sees this materialising in the next couple of quarters.
> Equities: There were some unexpected names in the list of top global equity performers of 2023, including Sri Lanka and Lebanon.
Jason Xavier, head of Europe, the Middle East and Africa exchange-traded fund capital markets at Franklin Templeton, advises clients to focus next year on markets he dubbed “diamonds in the rough.” — Bloomberg
Maria Elena Vizcaino and Colleen Goko write for Bloomberg. The views expressed here are the writer’s own.
