So in case you haven’t noticed, both Mexico and Turkey are careening headlong towards currency crises.
In Mexico’s case, traders are of course concerned about the impact Donald Trump’s trade policies will have on the economy. For more (and for a good laugh) see “Mexico To Buy Twitter?”
In Turkey, President Recep Tayyip Erdoğan has basically gone full-autocrat-retard in his quest to consolidate power and stamp out any semblance of dissent. He’s also decided he’s a rates strategist. Henceforth, high interest rates are tantamount to high treason and the central bank is basically scared to death to hike. You can read the full backstory in “Cold Turkey: Currency Crisis Looms For NATO’s Favorite Autocrat” and for those who want a bit more in the way of color, see “More Cold Turkey: Is It A Currency Crisis Or Not?”
Here’s a look at the performance of the peso and the lira over the past 12 months:
“Given the plunge, it’s time to take a flyer on at least one of these” – said no one, anywhere, ever.
Still, Goldman is out on Friday essentially asking itself the following question: “If someone put a gun to our head and forced us to get long one of the two currencies, which would it be?”
Here’s the answer, with some additional color.
One year ago, we published a large framework paper on assessing ‘fair value’ in EM FX – and concluded that, after three years of depreciation, EM FX had moved into undervaluation territory.
Since then, over the past year EM FX has recovered on a broad basis, but the two currencies that have seen the greatest losses are the TRY (-20% versus the USD) and the MXN (-15% versus the USD). As a result, these two currencies have cheapened to the largest extent over the past year, and both are now between 25%-30% undervalued on our fair value metrics.
A key question is therefore whether this observed cheapening is enough to take a constructive view on these currencies.
In our analytics, we have found that on a 1-2 year ahead horizon, this type of undervaluation signal can help predict an improvement in return prospects and the levels in both currencies are attractive from this standpoint. But for investors with shorter investment horizons, there are important differences and macro risks to consider. In the case of the MXN, while it is cheap relative to macro fundamentals, Mexico has the most to lose from a more protectionist US, and at least on that basis MXN has not overshot. For the TRY, it is approaching levels where new short positions are risky, but without a credible shift in policy stance it is hard to tell a constructive macro story here, and our 12-month forecast for $/TRY of 3.80 is basically in line with current spot levels.
If we had to pick one of these undervalued candidates for the coming year, we would prefer the MXN on the view that the actual protectionist impact of a Trump administration may be less severe than the rhetoric. Our 12-month forecast for $/MXN is 19, which is more than 10% stronger than current levels.