The most popular trade in emerging markets this year – betting on commodity-exporting countries – is losing its appeal.
Brazil’s currencies and bonds to Mexico and South Africa were the best performers among their developing country counterparts in the first five months of 2022 as commodity prices soared after the invasion of Ukraine by Russia.
They fell behind this month after growing fears of a global recession and Covid lockdowns in China caused a Bloomberg gauge of commodity prices to fall 10% from an eight-year high.
The loss of steam in the commodity-led recovery comes at a crucial time for emerging market investors, as Federal Reserve tightening undermines liquidity and deteriorates the outlook for riskier assets. They have nowhere to hide as the other half of the developing world – commodity importers mainly in Asia – also sees a sell-off amid stubborn inflation and delayed rate hike plans .
“We are closer to the end of the emerging market commodities boom than the beginning or even the middle,” said Todd Schubert, head of fixed income research at Bank of Singapore. “The growing risk of a harsh economic downtown will further undermine demand for a wide range of commodities.”
The Brazilian real, which gained 18% for the year to May, plunged about 10% in June. A similar reversal occurred for the Chilean and Colombian pesos and the South African rand. Their losses sent the emerging market currency benchmark to the worst quarterly losses in more than two years.
“I would be more defensive on commodity currencies at this time as it looks like slowing global growth and the search for global inflation to spike continue to weigh on the commodity space. said Galvin Chia, EM FX strategist at Natwest Markets in Singapore.
Citigroup Inc is urging investors to bet on further dollar gains against developing currencies, which “could see more broad-based weakness as commodity prices decline,” strategists including Dirk Willer and Luis Costa wrote. in a report Thursday.
“Commodity price resilience and high interest rate spreads have been supportive for Latin currencies” relative to other regions, they said. “That distinction could start to fade, with growth concerns also weighing on commodity prices.”
Commodity prices have been at the mercy of global growth concerns, as policymakers have only one primary objective – to rein in runaway inflation – even at the risk of tipping economies into recession. This has some investors saying the losses will only get worse from here.
“As far as the outperformance of commodity darlings in Latin America is concerned, this is as good as it gets,” said Witold Bahrke, Copenhagen-based senior macro strategist at Nordea Investment, adding that the asset manager had trimmed its exhibition in Latam. credit risk via credit default swaps.
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