Using sterling to buy emerging markets
Sterling looks likely to be one of this year’s big G10 currency casualties (the other being yen). Having lost 7 percent against the dollar and 5.5 percent to the euro so far this year on fear of a British triple-dip recession, sterling probably has further to fall. (see here for my colleague Anirban Nag’s take on sterling’s outlook).
Many see an opportunity here — as a convenient funding currency to invest in emerging markets. A funding currency requires low interest rates that can bankroll purchases of higher-yielding assets including stocks, other currencies, bonds and commodities. Sterling ticks those boxes. A funding currency must also not be subject to any appreciation risk for the duration of the trade. And here too, sterling appears to win, as the Bank of England’s remit widens to give it more leeway on monetary easing.
All in all, it’s a better option than the U.S. dollar, which was most used in recent years, or the pre-crisis favourite of the Swiss franc, says Bernd Berg, head of emerging FX strategy at Credit Suisse Private Bank.
Berg points out that while emerging currencies have been lacklustre this year against the dollar and euro, they have turned in a decent performance against sterling and yen. (check out his graphics below)
On the Brazilian real, Berg advises opening a 12-month short sterling, long real trade, targeting a 3 percent gain in this period. The real’s effective exchange rate has risen more than 7 percent since the start of the year, with gains of more than 16 percent against the yen and 14 percent against the pound. He is also recommending buying Mexican peso, Polish zloty, Turkish lira and Russian rouble against sterling and yen.
But those who have not moved in on the sterling-emerging FX trade yet are a bit wary. Huge short-sterling positions have been put on in recent weeks as expectation has grown of more QE in the UK, says UBS FX strategist Manik Narain (who incidentally likes the idea of sterling as an EM funding currency). Instead, he advises waiting for positioning to be shifted back from short sterling to neutral.