What’s Happening in EM: Funds Rework Playbooks (Podcast)

Emerging market investors are recalibrating their strategies following the dollar's July bounceback, prompting a shift in tactical trades. Funds are now favoring emerging-market dollar bonds over local currency debt as they adjust their near-term dollar views, reflecting a response to recent currency strength.

Analysis

A recent strengthening of the U.S. dollar during July is prompting a tactical shift among emerging-market (EM) investors. This currency movement is causing fund managers to recalibrate their near-term dollar expectations and adjust their investment playbooks accordingly. The primary change in strategy involves a rotation out of EM local currency debt and into EM dollar-denominated bonds. This move is a defensive measure designed to mitigate the negative impact of a stronger dollar on returns from assets denominated in local currencies, as such returns diminish when converted back into USD. The preference for dollar bonds indicates that while investors are seeking to reduce currency risk, they are not exiting the EM asset class entirely but are instead repositioning for a period of anticipated dollar strength.

Key Decisions for Investors

• Investors with exposure to emerging-market local currency debt should review their positions for increased currency risk due to the recent and potentially sustained strength of the U.S. dollar.
• Consider tactically reallocating from local currency-denominated EM assets to dollar-denominated EM bonds to hedge against adverse currency movements while maintaining exposure to the asset class.
• Closely monitor the U.S. dollar's trajectory, as the reported investor shift is based on near-term views and a reversal in the dollar could quickly restore the appeal of EM local currency debt.