Combination of real carry and value in EM FX remains attractive for the long term – Goldman Sachs

Kamakshya Trivedi, Research Analyst at Goldman Sachs, explains that a natural question after the sharp moves in EM currencies over the past week is whether they have moved too far.

Key Quotes

“In the very short term, the moves do seem much larger than what would be reasonable on our metrics, even taking into account the dovish moves in US rates, risk assets and volatility. But longer-term, the risk premium embedded in EM FX remains near cyclical highs. GSDEER undervaluation has receded from the trough observed in early 2016, but remains in undervaluation territory. At the same time, real carry has stayed high, helped by the ongoing convergence of inflation between the high yielders (where it is falling) and the US (where it is rising), which has more than offset the decline in the nominal carry.”

“Put differently, there are of course tactical risks to EM FX after the very sharp appreciation of recent days, and we discuss some of these in the next point, but the compensation on offer for these risks in EM FX is still generous, relative to history.”

“As a result, EM FX remains an attractive asset class relative to alternatives. That conclusion has a read-across to other EM asset classes. For example, EM equities, credit and local bonds all screen as more expensive than historical averages, but they are not as expensive as DM equity, credit and bonds.”