Morgan Stanley Sees ‘Uncomfortable’ Rally In Emerging Markets

Emerging-market assets should keep rallying for the rest of the year, but gains will likely be limited by a slowing global economy and US policy uncertainty, according to Morgan Stanley.

The Wall Street bank is predicting that developing currencies will modestly appreciate against the dollar by year-end while lagging some other G-10 currencies. A gauge of emerging-market currencies is up more than 5% this year, the best performance through May since 2017. 

“It's an uncomfortable rally then, amid significant uncertainty in the US and a global economic slowdown,” strategists including James Lord wrote in a note Friday. “Investors will need to hold their nerve.”

Local-currency bonds, which have been one of the asset class' best trades this year, are also seen gaining further amid lower US Treasury yields. The global backdrop might allow for central banks to cut rates if warranted “without having to worry too much about currency weakness,” they said.

Some of Morgan Stanley's favorite trades include wagering that the Chilean peso will strengthen against the dollar, scooping up Hungary's local bonds due in 2030 and betting on lower Brazil yields.

“Brazil remains our favorite market for receivers” in Latin America, strategists wrote, adding that they see lower interest-rate swaps maturing in 2029 and like inflation-linked government bonds due in 2028.