Currency option traders now price-in less volatility for the currencies of large emerging markets than for those of developed nations.
According to Bloomberg, the 3-month implied volatility for seven of the largest emerging market currencies dropped to 10% in March, which is lower than the 11.4% implied volatility priced-in for developed nations. This is based on a set of JP Morgan indices, the difference between the two groups is now the largest since July of 2008.
So far this year, eight of the 10 best-performing currencies are from emerging markets.
“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.”
The outlook for many emerging markets’ finances appears stronger right now has developed nations struggle with maturing populations and arguably unsustainable social spending pacts which are hard to reduce without triggering public outrage. Major emerging markets also have more potential for GDP growth given they are coming from a low base.
But let’s be clear that this is a well-worn consensus view by now and there is risk it has gone too far. The relatively stronger outlook for emerging market currencies unsurprisingly coincides with massive fund flows into emerging markets equities:
EPFR Global, April 8th:
Flows into EPFR Global-tracked emerging markets equity funds hit a 24-week high [for the week ending April 7th], Emerging Markets Bond Funds extended their current inflow streak to 22 straight weeks and Commodity Sector Funds absorbed another $265 million.
The combined Emerging Market Equity Funds tracked weekly by EPFR Global, with $569 billion in total assets, took in a net $3.27 billion during the week ending April 7 the biggest tally since the third week of October. That brings year to date inflows to $10.8 billion.
The geographically diversified GEM Equity Funds accounted for $2.01 billion of the inflow total. Flows into Asia Equity Funds hit a 17-week high, EMEA Equity Funds took in fresh money for the seventh consecutive week of inflows and Latin America Equity Funds recorded inflows for the sixth time in the past seven weeks.
While, we’re extremely bullish on the long-term prospects for major emerging markets, we’re just worried the pendulum of sentiment may have swing too far towards emerging markets and away from developing ones in the near term.
While developed nations have enormous long-term financial risks related to how mature their economies have become, and these have been a focus in the news lately, we should periodically remind ourselves how emerging markets have their own major risks, related to how immature their economies are.
So should we really expect less volatility from emerging market currencies than developed ones?
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