From Morgan Stanley:
Bottom line: Our economists now expect the Fed to hike rates in March, but we think high yield EM currencies will be able to weather the rate hike, while the EUR should stay weak. The significant tightening of G3 vs USD cross currency basis since the start of the year suggests that there is ample availability of offshore USD keeping global liquidity conditions loose. Unlike in 2013-2015, EM growth has improved, helped by robust DM demand, supporting higher asset prices and capital inflows,easing local financial and liquidity conditions. The key risk to our constructive EM view lies in disappointment on US fiscal stimulus and corporate tax cuts. Within EM, we are more cautious on TRY and hold on to our tactical short EUR/TRY trade with a tight stop. We also stay short EUR/MXN, USD/ARS, JPY/IDR and PHP/INR.
Don’t fear the Fed, and stay bullish high yield. The market pricing for a March rate hike has moved up to around 90% and most EM currencies have barely bothered to notice. Our view of a “split USD” – i.e.a USD that strengthens against G10 currencies and to some extent low yielding AXJ, but weakens against EM currencies,and high yield EM in particular – is playing out, and we continue to recommend a strategy of being overweight/long high yield EM, and underweight/short low yield.
