Citi FX guru Steven Englander argues that “the meta-theme in currency markets is the underperformance of commodity currencies versus diversified [emerging market] currencies.”
This summer, emerging markets have been thrashed by (1) rising Treasury yields in the United States and (2) China’s economic growth slowdown, which has negative implications for emerging-market economies that make their money exporting commodities to China.
Naturally, in such an environment, those emerging markets that are relatively more reliant on commodity exports than their peers (i.e., those with “commodity currencies”) will be worse off. Hence the “meta-theme” that Englander expresses in the trade charted below — a basket buying the Polish zloty, the Israeli shekel, the Mexican peso, and the Phillipine peso while simultaneously shorting the Canadian dollar, the Russian ruble, the Aussie dollar, and the South African rand.
Of course, the trade has been doing all right recently, and Englander highlights its consistency in a note to clients.
There’s also another key takeaway, though, according to Englander (emphasis added):
The other feature we would like to highlight is how hard it is to hold a good position with a conventional stop loss in the current environment. Visually the line chart looks like a straight line up since August of 2012, but there have been 14 instances when the pullback versus the high of the recent two weeks has been greater than 1%, so good risk management and tight stops would have taken investors out of the trade at least temporarily. So even if the overall performance of the trade has not been affected by mood changes in asset markets, the cut-risk environment since mid-May may have led to an essentially correct position being stopped out of risk management concerns. With a 2% stop-loss there would be no position cutting but is taking on much more [P&L] risk.
Keep in mind that in real time, no one knows that the trend will resume, so having witnessed the pullback, there is no guarantee that the underlying trend will resume, unlike the impression given by the chart. Our conclusion — even good positions are becoming increasingly difficult to hold.
That doesn’t apply just to emerging market currencies. Rising volatility in the U.S. Treasury market has spilled into other asset classes around the world as well, making this a problem for traders in a lot of different markets.
The chart below shows the performance of Englander’s emerging markets “meta-theme” basket.