The summer of soccer is over—and geopolitics and the Fed just took the pitch. Our EM strategists break down why they have locked in gains, where the Brazilian real goes from here, the South African rand's new vulnerability, and why the Korean won is the MVP of July.

• Abbas Keshvani (Desk Strategy), Asia Macro Strategist
• Daria Parkhomenko (Desk Strategy), FX Strategist
• Luis Estrada (Desk Strategy), LATAM FX Strategist

* Research Analyst opinions are their published views, independent of those expressed by Desk Analysts

Speaker 1:

Hello, and welcome to Macro Minutes. During each episode, we will be joined by RBC Capital Markets experts to provide high-conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures.

Dasha Parkhomenko:

Now, since we last recorded this podcast a month ago, the external landscape has been changing. The Iran conflict saw reescalation for most of July, taking Brent oil prices to $100 per barrel. But in the past week, news headlines have pointed to some deescalation, and this has taken oil prices lower again. Even though oil prices are off the local peak in July, the US dollar is still holding onto its gains as markets debate whether the Fed hikes or not rates on July 29th.

Luis, let me start with you. When we last recorded this podcast, and in our last EM Pulse publication, we discussed the summer of soccer and that carry would be an important driver in emerging markets this summer. What is the status of this theme since our last update?

Luis Estrada:

Hi, Dasha. Unfortunately, the summer of soccer theme is over early. We're back in a risk of regime driven by mainly three forces, the AI equity volatility, the renewed Federal Reserve hiking fears, and the rising oil prices. In a word, geopolitics are driving macro.

If you recall, by mid-July, Fed hiking expectations had dropped towards zero, but as soon as the Iran war hostilities restarted and oil spiked, Latin America currencies surrendered most of their earlier July gains as risk sentiment deteriorated. We flagged that the risk to our summer of soccer view was a reescalation of the Iran conflict, and as such, over the last few weeks, we've seen risk of rise quickly with the renewed bombing, we see the market is once again beginning to price a return towards $100 oil, and we believe the risk/reward has shifted materially. So we've taken profit on our recommendations linked to the summer of soccer carry positions. We closed our Brazilian real versus our Japanese yen low position that we initiated when we introduced the summer of soccer theme in early June. This had a 4.6% total return. We also closed a strategic Canadian dollar versus Brazil short. We opened six months ago, and we locked at 14% profit.

Our view on the region is intact, and our regional thesis remain intact too. However, at this stage, we prefer to protect gains and to wait for a more asymmetric structure to reenter these trade ideas.

Dasha Parkhomenko:

Thank you, Luis. I want to build on your comment that the risk/reward has shifted. What is your current view on high-yielding currencies in Latin America, and specifically the Brazilian real?

Luis Estrada:

That's a very good question, Dasha. We see headwinds in the short term. We see that risk/reward is shifting to neutral on carry in a low-liquidity environment that amplifies volatility and execution risk. We're also going through a period where AI-driven equity markets are driving macro, particularly in Asia where currencies such as the Taiwan dollar or the Korean won are being moved by equity flows.

In parallel, we're seeing renewed fears of FOMC hiking in Latin America. The high-yielders have been affected, and there is risk of a further escalation in Iran. So the Brazil real remains fragile as Brazil's presidential race intensifies. But the balance between fear and greed can quickly move back to pro-Brazil, even while event risk remains unusually high, especially if the Fed fears fade again after the July FOMC meeting.

Dasha, let me turn it back to you. Given the recent events, how do you see the South African rand, another high-beta currency, behaving?

Dasha Parkhomenko:

Thank you, Luis. Well, up until the SARB's rate decision on July 23rd, the South African rand was well-behaved in July, but I think the recent decision changes the short-term dynamics for the rand, and similar to your comment on the real, the rand is now also more fragile if the external backdrop deteriorates again, whether that is due to the Fed opting to hike rates or there's a reescalation on the Iran front.

So to give you some context on the decision that happened on July 23rd, the SARB surprised markets by holding rates. Four voted in favor of holding, two were in favor of hiking rates. There were two aspects that made this decision a surprise and resulted in a significantly negative reaction in the rand. One, markets were priced for a rate hike, and two, even though the SARB flagged a slight improvement in the inflation outlook, the statement pointed to conditions being problematic for services and inflation and that there are signs of strong inflation pressures based on the underlying inflation measures. So in this respect, the decision was a surprise for the rand.

Now, unless the external backdrop sees a significant improvement, a September rate hike is a live option for the SARB. But the problem for the rand is that there's quite a bit of time until we get to September 23rd, and that leaves the rand vulnerable to downside risk in the short term if there's a further deterioration in the external backdrop.

Luis Estrada:

Dasha, in last month podcast and in the June EM Pulse, you discussed that you expected Polish zloty to underperform versus the Czech koruna. Has this view changed?

Dasha Parkhomenko:

The short answer is that that view has not changed. The main justification for the Polish zloty to underperform the Czech koruna has been my view that there is some space for monetary policy divergence between the National Bank of Poland and the Czech National Bank. On a relative value perspective, I think that the Czech National Bank is likely to maintain a more hawkish stance than the National Bank of Poland. On the CNB side, the Central Bank delivered a rate hike in June, and even though there was a downside surprise in the latest CPI report in the Czech Republic, the Central Bank's press release flagged that services inflation is elevated. Whereas for the National Bank of Poland, we have been expecting the Central Bank to hold the policy rate unchanged for the foreseeable future, and that view has not changed. Even though for the National Bank of Poland, the rate path will be partly contingent, of course, on how the Iran conflict develops, which carries a great deal of uncertainty, and two, even though Governor Glapinski probably leans on the more dovish end of the spectrum within the NPC, I think Glapinski's dovish tone at the July press conference was very notable.

Speaking of relative value plays and idiosyncratic stories, Abbas, I want to turn it over to you. Why has the Korean won performed so well in the last month? Why are you long this currency?

Abbas Keshvani:

So the Korean won has been the outperformer in Asia and globally, and a large part of this is because we've seen the investment backdrop for Korea improve meaningfully. And when I say this, I mean that Korean companies... There's two very large Korean companies in particular which have committed to invest something like $1.3 trillion over the next 10 years. This is a colossal amount of money, something like $11 billion every single month. And you know how we talk about Korea having this huge trade surplus, and a lot of people scratch their heads about why that never translates into Korean won strength? Well, part of the reason is because Korean exporters don't really have a reason to bring the money home. It just swims in dollars outside the country a lot of the time. Well, now we finally have a reason for these guys to bring the money home and for there to be some kind of conversion and repatriation. And that would be a very positive impulse for the currency.

So on the back of this, we are very bullish on the Korean won. We have a long Korean won trade-on. And just to hedge against the war, we are funding it in currencies that, like Korea, are prone or rather vulnerable to higher energy prices, so INR and Euro, because they import energy, and IDR because it's not really an energy importer, but IDR is very vulnerable to higher inflation because they rely on foreign inflows into local currency debt. So the Korean won trade is hedged for the current war backdrop that we have, but the core thesis of it, of course, is about the FDI scenario, which has improved significantly for the country.

I should also say that one of the biggest bug-bearers of this currency, something that really dragged it weaker over the last few months, has been that very unfortunately there was all of this portfolio rebalancing taking place. It's very paradoxical because portfolio managers inadvertently found themselves overweight Korean stocks because of the outperformance of the KOSPI. So they were forced to sell Korean stocks, and that dragged the Korean won weaker. Well, the good news is that most of this appears to be behind us. I estimate that the average portfolio manager, the passive one at least, is slightly underweight Korean stocks now, so if anything, we should actually see some rebalancing inflows. That's not the reason that we have this trade-on, but it is important to mention that the chief detractor of the currency is no longer as concerning as it was previously.

Dasha Parkhomenko:

And another question for you, Abbas. The Trump administration recently introduced the Section 301 tariffs. Given Asia is reliant on exports, are you worried about the tariffs and what they mean for Asia?

Abbas Keshvani:

Asia FX can generally withstand the impact of the latest US tariffs. One thing to keep in mind is that they are merely a replacement for a temporary raft of tariffs. So if you remember, when the Supreme Court struck down the AIPA tariffs in February, Trump responded with temporary tariffs, which took effect from that point until roughly Friday. And they've pretty much been replaced now with this latest round of tariffs, which is around the same rate. So previously it was around 10%, a global tariff, the temporary one, and now we're looking at 10 to 12.5%. So it is pretty much a replacement.

We're not particularly worried because you haven't really seen the rate kick up significantly. And in actual fact, if we just zoom out a little bit, what we see is that Asian exporters have largely shrugged off a lot of the tariffs, as well as the policy uncertainty around them. So what we've actually seen is that exports to the US have grown robustly despite the implementations of various regimes of tariffs. And this is partly enabled by the region's competitive advantage. So I'm thinking of places like Korea, which export a lot of semiconductors, and nobody makes chips quite as advanced as Korea and Taiwan as well. So these countries are, a lot of these countries at least, are exporting goods that aren't as prone to tariffs because there really isn't a ready substitute domestically.

So not particularly worried about the tariffs in themselves. Like I said, a lot of the region has seen most of these tariffs already, and it's been pretty resilient through them. Probably a bigger concern for me if we're just talking about broad macro undercurrents would be oil because the on-off disruptions to energy supply in the Middle East are, of course, a drag on most of the region, which it tends to import oil and gas, and as a result, we recommend being hedged against the impact of higher energy prices. So our bullish Korean won trade is funded in currencies that are also exposed to the war, and we maintain our bullish CNH trade as a safe haven hedge.

Dasha Parkhomenko:

Thank you, Abbas. I think this is a good place to wrap up today's podcast. Abbas and Luis, thank you both for joining me on the show today. To our listeners, thank you for tuning in. For additional insights, please reach out to us or to your RBC sales representative, and we look forward to you joining us again next month as we continue to navigate emerging markets together.

Speaker 5:

This content is based on information available at the time it was recorded and is for informational purposes only. It is not an offer to buy or sell, or a solicitation, and no recommendations are implied. It is outside the scope of this communication to consider whether it is suitable for you and your financial objectives.