Fixed Income | Fund Selector Masterclass

In a recent panel discussion, we had the pleasure of hosting Helena Powell , Investment Director from Evelyn Partners , Eva Sun-Wai, CFA , Fund Manager at M&G Investments , and Abdelak Adjriou , Fund Manager at Carmignac . Our conversation delved into the intricacies of global currency movements, commodity markets, and their intertwined impact on investment strategies.

Understanding Emerging Market Currencies

Eva Sun Wai highlighted the strategic importance of specific emerging market (EM) currencies, driven by their commodity exports and macroeconomic conditions.

"We like the Chilean peso, as Chile is the world's largest copper producer, accounting for 30% of global production. Similarly, the Mexican peso benefits from nearshoring trends and offers a real rate story."

The Mexican Peso has been bolstered by nearshoring trends, which involve relocating manufacturing and production closer to the US market. This trend has been accelerating due to global supply chain disruptions and trade tensions between the US and China. Mexico's proximity to the US, coupled with the United States-Mexico-Canada Agreement (USMCA), makes it an attractive destination for companies seeking to reduce logistical risks and costs. Moreover, Mexico offers attractive real interest rates, which have drawn investor interest. The Banco de México (Banxico) has maintained a cautious monetary policy stance to control inflation, providing a favourable environment for currency appreciation.

Abdelak Adjriou echoed these sentiments, adding the Brazilian real to the list due to its booming agricultural sector and increasing oil production.

"We like the Brazilian real because of the boom in the agriculture sector and increasing oil production. When you have high carry rates, like Brazil's 10.5%, the total return potential is significant, even if the currency depreciates slightly over time."

The Brazilian Real has been supported by the country's position as a leading exporter of soybeans, sugar, coffee, and beef. The global demand for food commodities has been rising, and Brazil's agricultural exports have been a significant contributor to its trade surplus. In addition to agriculture, Brazil is also enhancing its role in the global oil market. The country has vast offshore oil reserves, and its production has been steadily increasing, making it one of the top oil producers in the world. This diversification in exports helps stabilize the economy and supports the real.

• How can investors effectively leverage commodity-backed currencies in their portfolios?
• What are the risks associated with high-yielding EM currencies amidst global economic volatility?

Developed Market Currencies: The Yen's Potential

The discussion also covered developed market currencies, particularly the Japanese Yen. Eva pointed out the yen's significant depreciation over the last three years, suggesting potential appreciation driven by global deflationary trends and anticipated policy shifts from the Bank of Japan. "We've seen the Yen depreciate by 35% in three years. In the short run, deflationary trends globally should help the yen," Eva remarked.

Abdelak added, "We like the Yen at current levels. Japan's GDP per capita has fallen dramatically due to yen weakness. Over the medium term, we expect appreciation."

But with the yen's undervaluation, what are the key indicators to watch for potential appreciation? And how might policy changes by the Bank of Japan influence the yen and broader market sentiment?

The Complex Dance of Dollar Dominance and De-dollarization

The dominance of the US dollar in global financial markets has been a cornerstone of international trade and finance for decades. However, the conversation around de-dollarization has gained momentum in recent years, driven by geopolitical shifts and changing economic dynamics. Abdelak and Eva delved into this complex issue, examining the implications for investors and the potential strategies to navigate this evolving landscape. Abdelak noted, "De-dollarization is a slow process. We're seeing central banks buying more gold and selling dollars, driven partly by the US's large fiscal deficit." Eva expanded on this, emphasizing that while there is a buzz around de-dollarization, the dollar remains dominant due to its resilience during crises and US economic outperformance.

The US dollar's dominance really took off after World War II with the Bretton Woods Agreement in 1944. This agreement made the dollar the world's primary reserve currency, pegged to gold, with other currencies tied to the dollar. The strength of the US economy and its political influence helped cement the dollar's role in global trade and finance.

Even when the Bretton Woods system ended in 1971, and the dollar was no longer convertible to gold, the dollar remained dominant. Its widespread use in international trade, the depth of US financial markets, and trust in the US government's economic management kept the dollar as the top choice for global transactions, central bank reserves, and investments.

De-dollarization

The concept of de-dollarization, while gradual, is being considered by many nations as a strategic move to enhance their economic sovereignty and reduce dependence on the US. Diversifying away from the dollar can mitigate the risks associated with the US's fiscal policies and economic decisions. For instance, holding a diversified portfolio of currencies and commodities can provide a hedge against the potential depreciation of the dollar.

Abdelak highlighted, "The dollar is losing its purchasing power due to the US's significant fiscal deficits. In response, central banks are turning to commodities like gold to safeguard their reserves against this devaluation."

Furthermore, a multipolar currency system could potentially enhance global financial stability. By reducing the dominance of any single currency, the global economy could become less susceptible to the economic policies and political decisions of one country. This could lead to a more balanced and resilient international financial system.

Commodities and Currency Correlations

Helena Powell steered the conversation towards the correlation between commodities and currencies. Eva pointed out,

"Copper has been significant for Chile, given their export dominance. For us, the performance has been strong, prompting a reduction in Chilean exposure."

Abdelak emphasized the broader structural factors favouring EM currencies, such as fiscal deficits, the green revolution, and real rates. "The green revolution benefits copper, and high carry rates in countries like Mexico and Brazil provide attractive total returns."

Nonetheless one wonders, how can investors balance commodity exposure with currency risk in emerging markets? And what long-term structural factors should be considered when investing in commodity-driven economies?

We invite you to reflect on these insights and consider how they might inform your investment strategies. What other currencies or commodities do you think will play a pivotal role in the coming years? How are you positioning your portfolios to navigate these trends?