The most common trade in emerging markets this year is being lost in value due to the fact that commodity-exporting nations are losing its appeal.
Commodity prices went up after Russia's invasion of Ukraine, as Brazil to Mexico and South Africa were the best performers among developing-nation peers in the first five months of 2022. A Bloomberg gauge of raw-material prices fell 10% from an eight-year high this month after growing fears of a global recession and China's Covid lockdowns.
The commodity-led rally came at a crucial point for emerging-market investors as the Federal Reserve tightens its liquidity and worsens the outlook for riskier assets. They have nowhere to hide as the other half of the developing world commodity importers mainly in Asia are witnessing a selloff amid stubborn inflation and delayed rate-hike plans.
Todd Schubert, head of fixed-income research at Bank of Singapore, said that we are closer to the end of the emerging-market commodity boom than the beginning or even the middle. The rise in the risk of a severe economic downtown will sap demand for a broad swath of commodities. The Brazilian real, which rallied 18% in the year through May, has plunged about 10% in June. A similar reversal has occurred in the South African rand and the Chilean and Colombian pesos. The emerging-market currency benchmark has fallen to the worst quarterly loss in more than two years because of their losses.
Galvin Chia, EM FX strategist at Natwest Markets in Singapore, said that I would be more defensive on commodity currencies as it seems that slower global growth and the search for peak inflation globally continue to weigh on the commodity space.
In a report published Thursday, strategists including Dirk Willer and Luis Costa said that investors should bet on further gains in the dollar against developing currencies, which may see more broad-based weakness with commodity prices declining.
Resilient commodity prices and high interest-rate differentials have been favorable for Latam currencies compared to the other regions, they said. Growth concerns weighing on commodity prices may cause this distinction to blur. Policy makers have only one main goal - to tame runaway inflation - even at the risk of tipping economies into a recession, as raw-material prices have been at the mercy of global growth concerns. Some investors say the losses will only deepen from here.
Witold Bahrke, a Copenhagen-based senior macro strategist at Nordea Investment, said that the asset manager has reduced exposure to Latam credit risk via credit default swaps when it comes to the outperformance of the commodity darlings in Latin-America.
The Age of Credibility for Central Banks is no longer over.