Guest Commentary: The Weekly Macro View - Money To Be Made In Emerging Market FX | Learn Forex | GoLearnForex.com

For the last few weeks we have pontificated on the doom and gloom that surrounds the euro region at present, as well as many other major economic powers (including the US, Japan, China, Britain and others). Naturally in any scenario there is always money to be made and we are compelled this week to share our thoughts about emerging market economies, particularly those surrounding the euro area.

Emerging markets have been faring very well considering the general outlook in most financial hubs is pretty bleak, with these economies continuing to race forward. While most look to China and other BRIC nations to lead the charge, smaller countries like Turkey (which registered China-level growth of 9% in 2010) and Poland (the only EU member to avoid a recession in 2009) have been growing at a fair clip too. However, as the euro zone slips back into recession and the currency union struggles to bring its house in order, it is these neighbouring economies which are set to bear their share of the punishment.

Euro zone banks are likely to be the primary conduit for this pain as they try to adhere to higher capital-ratio targets as part of the deal last month to rescue the euro. According to data from the Bank for International Settlements, European banks have outstanding loans to eastern Europe to the tune of €1.3 trillion. If European banks decide to focus on their business at home and sacrifice some of their foreign lending business, this could severely curtail the supply of credit to emerging markets. We have already seen some leading banks take such a measure; Germany’s second largest bank, Commerzbank, has said it will cease lending outside its home market with the exception of Poland.

Looking at a nation’s current account balance can be an insightful gauge to just how vulnerable they may be; nations with current account deficits are likely to be relying on foreign money to fill budget gaps. Turkey and Poland look the most exposed with current account deficits around 10% of GDP this year (according to IMF data), however, as we have mentioned, the lifeline into Commerzbank and western Europe should solidify Poland’s outlook. Hungary is also worthy of mention; despite its surplus, they still have a financing gap due to IMF repayments and after a recent, very public, disagreement with the IMF, investors are exiting the nation which could see credit dry up.

This drying up of foreign credit has already been a major factor in the recent drops that we have seen in currency value against the US dollar since early in 2011. The Hungarian forint tops the table with around a 22% drop, followed by the Polish zloty and the South African rand. Lower down the table is the Indian rupee, the Russian ruble and Bulgarian lev, which have all lost around 10% of their value against the greenback in recent months. As we suggested above, it’s this downward pressure on currencies in nations reliant on foreign capital that could be an enticing investment opportunity.

Trend players and those who are bearish on the medium-term outlook for the euro zone and global economy should certainly feel that there is still plenty of downside in most, if not all, of these currencies and even entering short positions at current levels against the likes of the US dollar (or other majors) should pay handsomely. The counter-trend investor will see the flip side of this, suggesting that since most of the selling has been done and was not based on the underlying fundamentals (with some technical studies also nearing over sold territory), attractive long positions could be established for medium-term players at these levels. In addition, should these currencies lose more of their value, the position becomes all the more alluring, offering better entry levels.

There is one final point worth mentioning. Banks in the euro region are not the only route to foreign capital for emerging markets; foreign investments in domestic bonds and stocks have been an important source of capital too. These inflows have held up remarkably well in recent turbulence as investors seek more attractive interest rates, eager to avoid the low yields that most developed economies are offering. However, should currencies lose too much of their value this would result in losses on these investments, which in all likelihood would choke off these inflows, in turn pressing the currency yet lower.

With pressure mounting on the euro zone and few aware to the risks that current problems pose to Europe’s closest neighbours, it is the authors’ contention that there is still plenty of downside in these currencies. Even calls from the European Bank for Reconstruction and Development to enact a second Vienna Initiative (a program in 2009 which kept money flowing to eastern Europe) have fallen on deaf ears as have the warnings of the IMF. With market participants so focused on what is going on in Europe, there are few watching what is happening right next door. We therefore recommend playing most emerging market currencies short into the first half of 2012 before looking to enter medium term long positions to capitalise on the sharp reversal.

Written by Jonathan Granby

Jonathan Granby is a financial writer and blogger who contributes regularly to DailyFX, Seeking Alpha and is a regional contributor for Aslan Media. Jonathan is a published writer with pieces appearing in leading U.S. journals on the topics of economics and finance. He has previously held positions in financial services and before that was the Freedom Fellow at JIMS, an economic think tank.

Follow Jonathan on Twitter @JonnyGranby or email directly at This e-mail address is being protected from spambots. You need JavaScript enabled to view it