Synopsis:

Goldman Sachs adopts a defensive stance on Emerging Market Foreign Exchange (EMFX) for the second half of 2024. Despite a supportive fundamental backdrop, uncertainties surrounding the US elections and potential US rate movements prompt caution.

Key Points:

1. H1 Market Behavior:

   • EM Local Rates: Struggled with direction, experiencing resilience followed by a sell-off due to higher US rates and volatility within EM markets.
   • Fundamental Backdrop: Disinflationary trends from the previous year have largely remained intact, supporting EM fundamentals.

2. H2 Concerns:

   • US Elections Impact: Uncertainties related to the US elections could affect the EMFX market, particularly if there is a steepening of the US yield curve or the imposition of tariffs.
   • Cross-Asset Correlation: High correlation between FX and rates within EM markets suggests broad-based vulnerability.

3. Market Vulnerabilities:

   • Higher Sensitivity: Local rate markets in Brazil, South Africa, and Korea may be more susceptible to increased prospects of a Trump victory.
   • Relative Safety: Markets with lower sensitivities to US political developments and economic shocks are preferred.

4. Investment Recommendations:

   • India: Long 2Y Indian Government Bonds (FX-unhedged).
   • Czech Republic: Receive 5Y5Y Interest Rate Swaps (IRS) in CZK versus EUR.
   • Poland: Long 9Y Polish Government Bonds (FX-unhedged vs EUR).
   • Mexico: Among high-yielding markets, Mexico is seen as having relatively lower sensitivities, providing a buffer with its long-end spread versus the US.

Conclusion:

Goldman Sachs' defensive stance on EMFX for the second half of the year is driven by the potential impacts of the US elections and rate movements. Their recommendations focus on markets and instruments likely to be more insulated from these shocks, emphasizing lower sensitivity and higher resilience.