An Outflow from Emerging Market Currencies Could Signal Weakness

The strength of emerging markets (EM) is often tied to their respective currency and right now, EM currencies are on the ropes, which means that more weakness could be ahead.

“Emerging market currencies have been among the biggest market casualties of the Covid-19 outbreak as their generally weaker home economies have seen cash flow out as investor risk-aversion rises. However, while their fortunes have differed, it’s very difficult to see them thriving in an aftermath which promises plenty of headwinds,” Daily FX analyst David Cottle noted. “The Mexican Peso will serve as a pretty good exemplar of the process so far. It has understandably fallen sharply against anti-risk plays such as the US Dollar as the crisis has developed and shows little sign of clawing back much-lost ground.”

One ETF to watch is the WisdomTree Emerging Currency Strategy Fund (CEW). CEW seeks to achieve total returns reflective of both money market rates in selected emerging market countries available to foreign investors and changes to the value of these currencies relative to the U.S. dollar.

The fund will invest, under normal circumstances, at least 80% of its net assets, plus the amount of any borrowings for investment purposes, in investments whose combined performance is tied economically to selected emerging market countries. It generally will maintain a weighted average portfolio maturity of 90 days or less with respect to the money market securities in its portfolio.

Relatively Speaking: Developed Markets

Weakness in EM means investors looking to take advantage of developed markets can consider the Direxion MSCI Developed Over Emerging Markets ETF (NYSEArca: RWDE). RWDE provides a means to not only see developed markets perform well, but a way to access a convergence/catch-up in performance of DM relative to EM, a spread that has clearly widened over the past 6 months. The fund seeks investment results, before fees and expenses, that track the MSCI EAFE IMI – Emerging Markets IMI 150/50 Return Spread Index.

The index measures the performance of a portfolio that has 150% long exposure to the MSCI EAFE IMI Index (the “Long Component”) and 50% short exposure to the MSCI Emerging Markets IMI Index (the “Short Component”). On a monthly basis, the Index will rebalance such that the weight of the Long Component is equal to 150% and the weight of the Short Component is equal to 50% of the Index value. In tracking the Index, the Fund seeks to provide a vehicle for investors looking to efficiently express a developed over emerging investment view by overweighting exposure to the Long Component and shorting exposure to the Short Component.

For more relative market trends, visit our Relative Value Channel.