Three-month implied volatility for the seven biggest developing country currencies fell to 10 percent in March compared with 11.4 percent for industrialized nations, according to JPMorgan Chase & Co. indexes. The gap is the widest since July 2008. So far this year, eight of the 10 best-performing currencies are from emerging markets.
The record U.S. budget deficit, Europe’s bailout of Greece and the prospect of a hung parliament in the U.K. are increasing the risk of losses in dollars, euros and pounds. In developing markets, the deficit fell to one-third the level of advanced nations this year and the economies are growing twice as fast as the U.S., the International Monetary Fund says.
“The global perception of risk is changing,” said Jerome Booth, who helps manage $32 billion in emerging-market assets as the head of research at Ashmore Investment Management Ltd. in London. “Where you want to be is non-leveraged places, and that means anything in emerging-markets. This is a start of a trend. The rally in emerging-markets has barely started yet.”
Global Recovery
That’s a switch from three years ago, when record-low volatility was fueled by investors underestimating the risks of leverage. Now, volatility is declining in developing markets as countries from China to Brazil lead the global recovery, while swelling budget deficits in the U.K. and U.S. will weaken those nations’ currencies, Booth said.
Emerging-market currencies were mixed as of 12:01 p.m. in New York. Russia’s ruble rose 0.4 percent against the dollar to its strongest level in more than four months, while Hungary’s forint appreciated 0.7 percent versus the euro. The Thai baht weakened 0.3 percent against the dollar after a clash between soldiers and protesters left as many as 21 people dead.
The MSCI Emerging Markets Index of shares slipped 0.1 percent. The extra yield investors demand to own emerging-market debt over U.S. Treasuries was little changed at 2.42 percentage points, according to JPMorgan Chase & Co.’s EMBI+ Index.
China’s imports surged 66 percent in March from a year earlier, causing the country’s first trade deficit since 2004. The increase in imports helps the global economic recovery, Huang Guohua, the head of the customs bureau’s statistics department, said on April 9.
Lira Rally
The Turkish lira has climbed 6.8 percent against the euro this year through April 9, reaching the strongest intraday level since December 2008. Gross domestic product increased at an annual rate of 6 percent in the fourth quarter of 2009, lagging behind only China among the Group of 20 nations. Goldman Sachs Group Inc. forecasts the expansion may help Turkey’s $620- billion economy overtake Germany to become the third-biggest in Europe by 2050.
The implied volatility for the lira is below that of the pound by the most since 2000. The lira was forecast to fluctuate at an annual rate of 10.6 percent in the next three months, as of March 30, 2.7 percentage points less than the pound, data compiled by Bloomberg show.
“Dropping volatility says: ‘Buy, buy, buy,” said Sebastien Galy, a currency strategist at BNP Paribas SA in New York.
U.K. Budget
In the U.K., the pound is down 5 percent versus the dollar this year and has fallen against 14 of 16 most-traded currencies, including an 11.7 percent drop against the Mexican peso. National elections are raising the prospect that U.K. voters may fail to elect a governing majority for the first time since 1974. A weakened government may struggle to enact budget cuts with the nation’s debt set to almost double.
The euro has lost 12 percent versus the Mexican peso this year as Europe weighed options to help Greece avoid default on its debt. European governments offered Greece a rescue package worth as much as 45 billion euros ($61 billion) yesterday at below-market interest rates.
“Investors had a bit of a blasé attitude prior to the Greek situation,” said Robert Stewart, who oversees $74 billion as the head of currencies at JPMorgan Asset Management in London. “Investors are slowly awakening to the reality.”
Three decades ago, emerging-market currencies fluctuated the most amid debt crises and hyper-inflation. Mexico defaulted in 1982 while the Asian financial crisis that started in 1997 wiped out one third of the region’s economy.
U.S. Debt
Now it’s developed countries that are dealing with the biggest debt. The administration of President Barack Obama predicts its budget deficit will swell to a record $1.6 trillion in the fiscal year ending Sept. 30. Moody’s Investors Service forecasts that the U.S. will spend more on debt service as a percentage of revenue this year than any other top-rated country except the U.K.
Emerging nations are moving in the opposite direction. The budget deficit for developing countries will fall to 2.8 percent of their economies this year, from 4 percent in 2009, according to an IMF report in November. Industrialized governments’ budget gap will decline to 8.1 percent from 8.9 percent, the Washington-based fund said.
Developing nations reduced their foreign debt to 26 percent of GDP last year from 41 percent in 1999, while advanced nations’ debt may surge to 106.7 percent of GDP this year from 78.2 percent in 2007, according to IMF data.
Credit Crisis
In July 2007, the JPMorgan Emerging Market Volatility Index fell to a record low of 5.8 percent as central banks made their interest-rate and currency moves more predictable. When credit markets froze later that year, the index began rising and hit a record 35.8 percent in October 2008, one month after Lehman Brothers Holdings Inc. collapsed. The JPMorgan G-7 Volatility Index, including the euro, the pound and the yen, reached 26.6 percent.
Emerging-market volatility is falling again as the Mexican peso and the Malaysian ringgit gained 7.6 percent and 6.7 percent versus the dollar this year, the best performers in the world after the Costa Rican colon.
Mexico’s government forecasts it will keep the budget deficit at 2.8 percent of GDP this year after lowering spending and increasing taxes even as the economy shrank 6.5 percent in 2009 in its worst recession since 1932.
Mexican Peso
The implied volatility of the Mexican peso was 1.39 percentage points below that of the euro as of April 1, the most since October 2008, according to Bloomberg data.
Exports from Malaysia, South Korea and Taiwan are growing to feed demand in China, which is leading the global economic recovery. Overseas shipments from Malaysia rose 18.4 percent in February from a year earlier. The central bank has raised its growth forecast for Southeast Asia’s third-largest economy, predicting an expansion of as much as 5.5 percent this year, the fastest since 2007. Korea exports climbed 35.1 percent in March from a year earlier, while Taiwan’s surged 50.1 percent.
Investors may be overlooking the risks of developing- nations, said Harald Hild, a money manager at Quaesta Capital Optivest AG in Switzerland, which oversees about $1 billion. The South African rand, Colombian peso and Brazilian real have increased more than 20 percent in the past year against the dollar, making their exports more expensive. These countries are also “highly dependent” on the U.S. and may falter should America’s economic recovery stumble, he said.
“It’s really amazing how strong the risk appetite is for emerging-market currencies,” said Hild, who has traded currency options for 16 years. “I’m not sure how long this will hold.”
‘Strategic Trend’
Countries from Chile to China may lure $722 billion in overseas investment this year, 66 percent more than in 2009, the Washington-based Institute of International Finance said in January. Developing-nation bond funds attracted $7 billion this year, pushing assets under management to a record $74.7 billion, according to Cambridge, Massachusetts-based research company EPFR Global.
Falling volatility is making emerging-market currencies more attractive, especially to investors in carry trades, said Thanos Papasavvas, head of currency management at Investec Asset Management in London. In such trades, investors borrow in countries with low interest rates to buy financial assets in those with higher yields.
“You’ll see the appreciation of emerging-market currencies versus developed-market currencies as a long-term, strategic trend,” said JPMorgan’s Stewart. “Investors will allocate more to emerging markets.”
