(Bloomberg) — The U.S. dollar’s bearish turn has opened the floodgates into emerging markets, helping currencies to get on board a rally so far driven by equities and bonds.
The MSCI gauge for emerging-market exchange rates had the best weekly advance in more than four years and is flashing indicators of further gains. That’s helped to add at least $1 trillion to the market value of emerging-market assets this week alone.
It’s breakthrough many investors have been waiting for in the past 10 weeks to assess whether the rebound from the March slump was sustainable. Gains during were driven by domestic demand, and dollar-based investors largely stayed away. But now, the appeal of the carry trade and the hunt for yield is rising.
“The flush dollar-liquidity conditions should drive financial market flows away from the U.S. and back towards emerging and other markets,” said Eddie Cheung, an emerging-markets strategist at Credit Agricole SA in Hong Kong.
History suggests foreign investors will take the plunge.
In January 2016, on the heels of the Federal Reserve’s first rate increase in almost a decade, emerging-market equities began a tentative advance. It was not until March that currencies joined the rally, but once they did, the trend snowballed and gains continued until January 2018. Stocks alone added $8 trillion.
Our story from 2016: Five Charts Show Emerging Stocks Rally May Be Real Thing
This week, investors got a glimpse of that all-round performance. Emerging-market stocks added $800 billion in the first four days of the week, while bond benchmarks added $40 billion. Exchange-traded-fund flows have turned positive. Added to all this, Friday’s gains for stocks, bonds and currencies will probably take weekly net flows above $1 trillion.
The Brazilian real posted the best performance of 24 emerging-market currencies tracked by Bloomberg, up 7.6% in the week. The Indonesian rupiah climbed more than 5%. The Chilean peso appreciated 4.9%.
The MSCI Emerging Markets Currency Index rose above the 38.2% Fibonacci retracement from the March rout. If the gauge consolidates above that threshold, it may post further gains. Meanwhile, options traders have cut expectations for volatility in currencies for a sixth successive week, the longest streak since February 2017. Cumulative carry-trade gains have risen for a third week.
“The focus is on the future, and this is where markets are expecting things to start improving,” said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. in Singapore.
(Updates currency outperformances in eighth paragraph.)