In this month's Emerging Markets edition, Luis Estrada is joined by Abbas Keshvani and Dasha Parkhomenko to analyze recent developments across emerging markets. The discussion covers the changing direction of the US dollar, preferred trades for the current environment, and key risks to their outlook.

Participants:

• 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'll 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.

The implication is ironic. The new Fed chair, Kevin Warsh, could potentially be the one hiking rates. That's controversial given that Warsh was appointed by President Trump and is widely viewed as someone biased to cut rates. As a result, many analysts have just ignored the market and pushed their expectations for Fed easing into the 2027 cycle. All of this is unfolding just as the FIFA World Cup kicks off, adding another layer of distraction and disruption to markets. As the summer of soccer gets underway and assuming geopolitical tensions and treasury volatility begins to settle, let's dive into our latest views. Dasha, let's start with the dollar. How do you expect the US dollar to behave over the summer?

The first was this idea that the Fed was going to cut rates that would cause a narrowing in the rates differential between the US dollar and the rest of G10 and that would translate into higher hedge ratios by foreigners on dollar assets and thereby translate into dollar selling. The second driver was diversification out of the US, into the rest of the world, into Europe, into Asia as well. And then the third factor was this idea of US policy uncertainty causing a higher risk premium on US assets, and that's translating into more hedging of dollar exposure. Now I think the landscape has changed. The first change is that our US rates team is no longer expecting rate cuts. So if we take that into account and also our views on other G10 central banks, then the rates differential between the US dollar and in particular the lower yielding currencies in the G10 space is likely to remain wide.

Luis: Perfect. Abbas, the CNH has been remarkably insulated from much of the FX volatility we've seen elsewhere. What's your outlook for CNH this summer and how much of that depends on the direction of the dollar?

Abbas: Well, Louis, as you know, we've been bullish on CNH since November and we've had a long CNH trade on versus dollars and euros equally weighted. The trade is making something like 4.7% total return including carry and bid offer. So I am naturally very protective of this P&L and I'm constantly vigilant about any kind of turn in CNH. But so far I've been happy to see the PBOC continuing to fix dollar CNY lower. And this has happened even as the dollar started moving higher over the course of the war. So we saw the euro weaken, we saw the yen weaken, but we saw the PBOC continuing to fix CNY stronger. And I think that speaks to the fact that they have ambitions for internationalization of the currency and also there is increasing external pressure on them to keep appreciating the yuan. So that's kept them on an appreciation bias.

I'll touch more on this in a little bit, but so far it has worked out quite well. China's fundamentals are also pretty solid in favor of stronger currency. The trade surplus is absolutely solid. Last year's surplus was something like 1.2 trillion yuan and increasingly the exporters exhibit a tendency to convert this surplus, which is very important in terms of transmission into currency strength. And finally, the currency also exhibits tremendous safe haven properties. We've seen Chinese bonds relatively insulated from the inflationary impacts of the war, which has allowed them to function as a sort of haven since the start of the war and it's allowed CNY to function as a haven in part. It also helps that China obviously doesn't import as much energy as a lot of its other peers in Asia. So all of this kind of informs a relatively constructive approach towards CNY.

We're also looking forward to a specific catalyst, which is we want to wait for additional incremental fiscal stimulus, which would improve the cyclical outlook for China, and that would be the next leg lower in dollar CNH. So that's essentially why we have this bullish CNH stance. We continue to hold it. But I will say that over the last week or so, I have noted with some caution that the PBOC have started to fix dollar CNY higher where we've had a five-day streak of higher fixes now, which is the longest such streak in around two months. So it does warrant a little bit of scrutiny. I'm very mindful of the fact that clearly they don't have the same bias for steering the currency stronger as they did say a month ago. And I'm very watchful for any kind of shift in fixing approach or currency appreciation approach.

I'm also worried about the trade talks between the EU and China because if the EU decides to respond to what they see as imbalances, if they respond to that with tariffs or some kind of protectionist measure against Chinese exports, then there's less of an impetus for China to keep fixing the currency stronger. So the first point, which I raised, which is we see the PBOC continuing to fix CNY stronger, that point needs special attention over the coming weeks, just because if there's a shift in stance, it would warrant us taking profit on our Bullish CNH view.

Luis: Good question, Dasha. I believe the carry will continue to outperform over the summer, but given that the dollar is going to be strong, we prefer using lower yielding currencies to fund these carry trades, but definitely not using the dollar. Trades like BRL, Japanese yen remain very attractive. We think these can reach 32 sometime by the end of the summer. Speaking of the lower yielders, what are your favorite funding currencies and which EMEA trade stands out heading into the summer?

Dasha: Yeah. So on the first part of your question, Luis, I did do some work around this topic recently in terms of what are the better funding currencies. For context, we have a carry trade barometer that screens for efficient funding currencies for each high yielding currency in both G10 and EM. And the one currency that stands out as the most efficient funder is Swiss Franc, in particular looking against Long HUF, Long Polish Zloty, also against a number of Latin American currencies too, for example, long BRL, which you like. So the Swiss francs tends to be one of the better funding currencies based on our carry trade barometer. Now, if I can deviate a little bit from the carry theme, I do think that there is potentially scope for a relative value play over the coming months when you look at the Polish zloty versus the Czech Koruna and specifically there may be some space for the Polish zloty to underperform versus the Czech Koruna.

They delivered a hike at their June meeting. You did have one of the members from the CNB saying that this is not the start of the tightening cycle, but I do think that in relative terms, the National Bank of Poland is more dovish right now than the Czech National Bank, which means that you could potentially have more downside momentum in that pair, PLN/CZK. So that would be a pair I would watch if you do get more dollar strength, even if it's gradual and if you do have that relative rates dynamic story playing out Abbas, heading into the summer and assuming that lower oil generally helps effects and bond volatility declines, what are your strongest convictions in Asia?

Abbas: Well, Dasha, my strongest convictions in Asia are that I would like to turn more constructive on the energy importers because a lot of our currencies here in Asia are energy importers and they depend on imports of oil and gas. So they've had a rough last few months because of the war and higher oil prices. I'm thinking specifically about the Korean won and the Thai baht. These are two currencies that have really depreciated since the start of the war and now that oil prices are below $80 in Brent, the environment is a lot more forgiving to these currencies and actually some of their macro fundamentals can stand out. In Korea's case, we've got the ongoing WGBI inclusion, which is worth seven yard of inflows, FX unhedged per month and that's no chump change. It's equivalent to Korea's average trade surplus for last year. So that's a lot of money coming in and I think it would be sufficient to strengthen the currency.

I also note, and this is not about the war necessarily, but I also note that some of the drags on the won like the retail outflows or the portfolio rebalancing by the foreign investors, they appear to be behind us or at least they've dissipated significantly. So the drags on this currency are less. The thrusts are still live and the wartime considerations that kept me at bay are fading in the background. So I do like the Korean won. I think on a relative basis, it might be a good one to turn constructive on. Certainly not against the dollar right now just because the bullish tone in dollar Asia, but I'm certainly on an RV basis that's something I'm looking at potentially. And then the Thai baht is another one I really like. Outside of a wartime scenario, Thailand enjoys solid tourist arrivals, which are responsible for two to $3 billion of inflows into the country.

And that's enough to basically strengthen the currency on a protracted basis. So I do like this currency. I think it's weakened a great deal since the war and this is actually looking like a pretty attractive entry level. So I've got that on my radar. Again, more in the RV space than anything else. I'm certainly not against dollars right now, but Korea and Thai baht, these are potentially two trades I think could work out quite well given lower oil prices.

Dasha: Thank you, Abbas. So let me turn it back to you again, Luis. There's quite a few political and idiosyncratic events in Latin America. What are the risks for Latin America carry trades over the summer months?

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