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The big bad imbalance: EM FX vs. US dollar positioning

Market Commentary

02 April 2014

Investors are rightly taking a fresh look at adding Emerging Markets (EM) exposure after nearly a 12 month EM bear market. Technicals are better, valuations attractive, and EM has shown fundamental resilience in the face of shrill media pessimism and two ‘taper-tantrum’ related outflows. Still, one thing holds back many potential investors from putting money to work in EM, namely the fear of currency volatility. That EM FX is volatile should surprise no one, but are investors really right to fear it to the extent that they avoid investing entirely? We think not. In fact, we think the fear of EM FX volatility is both irrational and dangerous. EM FX volatility is lower than EURUSD volatility and returns are greater. More importantly, the fear of EM FX volatility is contributing to big imbalances in global currency positioning in favour of the Dollar and against EM currencies at a time when strong macroeconomic forces suggest investors should position the other way around. The best way for investors to protect the purchasing power of their assets and to ensure against the impending fall in the Dollar is to exploit the current (extreme in our view) pessimism about EM FX to reduce their exposure to Dollar assets.

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