Finance minister John Connally achieved global fame in 1971 with the comment that “The US dollar is our currency but your problem”. The then member of the Nixon government is still quoted frequently today. The dominance of the US dollar, however, is increasingly being called into question. The BRICS states especially, an economic grouping made of Brazil, Russia, India, China and South Africa, would like to form a counterbalance. This quintet, which accounts for some 40% of the world's population, has long been demanding reform of the international currency and financial order. At the 14th BRICS summit last year, the five member states announced they were working on a “new global reserve currency”.
It is not only efforts such as these that could impair the US dollar’s dominance: the emerging countries also enjoy an interest rate advantage over the USA as well as brighter economic prospects. According to the forecasts published by the International Monetary Fund (IMF) in January, US growth will slow to 1.4% this year and then to 1.0% in 2024. By comparison, the IMF reckons emerging markets will expand by 4.% in 2023 and 4.2% in 2024. Market players see these trends as fertile ground for EM carry trades. In a carry trade, capital is raised in regions with low interest rates and invested in higher interest-bearing securities in a different currency in another market.
LAccording to Jon Harrison, managing director for emerging market macro strategy at TS Lombard, the Brazilian real and the Mexican peso have recently been the top targets for EM carry trades as they are supported by proactive central banks and relatively high real interest rates. This is reflected by movements in exchange rates: the real has appreciated 7.0% against the US dollar this year alone, while the figure for the MXN/USD FX duo is as high as 7.5%. This is a trend that is being seen across the board in emerging markets, with the Emerging Market Currency Index, the MSCI EM FX, for instance, in which the Chinese renminbi is the heavyweight with a 30% share, climbing just under 3% this year.
Leonteq has taken the latest developments on the foreign exchange markets as an opportunity to put together an interesting basket in which five EM currencies compete against the US dollar: the Chinese renminbi, the Indian rupee, the Brazilian real, the Mexican peso and the South African rand. The new “Inverse Capital Protected Note” enables investors to take advantage of a further appreciation of the five EM currencies against the US dollar while protecting their capital. The product has a term of 18 months and participates at a high rate of 250% in the equally weighted basket comprising USD/BRL, USD/MXN, USD/ZAR, USD/INR and USD/CNH. The capital protection level is 100%, which means that the nominal is fully protected at the end of the term.
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