Thu Jul 29, 2004
By Gertrude Chavez

NEW YORK (Reuters) - A year ago, betting on the dollar against the more lucrative emerging market currencies would have been a recipe for disaster.

But since Federal Reserve Chairman Alan Greenspan's bullish remarks on the U.S. economy last week, the dollar has gained broadly, with some of the high-yielding emerging market currencies taking the sharpest hits.

Since then, the Brazilian real has lost around 3 percent against the dollar, the Turkish lira plunged some 7 percent and the Thai baht fell about 2 percent.

Markets took Greenspan's comments to mean the Fed would raise U.S. interest rates faster than many had thought.

Higher rates on short-dated dollar deposits tend to make these U.S. instruments more attractive to global investors.

"Markets are more convinced that we are going to get regular quarter-point (rate) tightenings," said Peter Frank, senior currency strategist at ABN Amro in Chicago.

Frank said the market had been beset by uncertainty until the Fed chief spoke, due to weak growth data in June, but added "Greenspan dispelled that, and as long as we have strong U.S. data, the market will expect the Fed to tighten at every single (policy) ... meeting this year."

Strategists have thus recommended buying the dollar against currencies such as the Turkish lira, the real and the baht.

These currencies, analysts noted, have consistently posted losses against the dollar over the last three months, following strong U.S. data and the subsequent rise in Treasury yields.

Marc Chandler, currency strategist at HSBC in New York, said that in a rising U.S. rate environment, "it's going to be tough to see Brazil and Turkey do well because they are two of the largest debtors among emerging markets."

A rising dollar could increase emerging nations' debt service obligations, Chandler said, since the bulk of their loans are denominated in dollars.

SOME VALUE IN ASIAN CURRENCIES

Among Asian emerging market currencies, analysts say profits could be made selling the Thai baht and Singapore dollar because of their low domestic rates. Thailand's benchmark 14-day repurchase rate is 1.25 percent, while Singapore's overnight rates are around 0.7 percent.

Further hurting the Singapore dollar, according to HSBC's Chandler, is the fact that it tracks the yen . Traders have shied away from buying the yen recently despite robust economic numbers, as the recent surge in crude oil prices could hurt Japan, whose economy is highly dependent on imported oil.

Prospects for U.S. rate hikes and a strong dollar typically augur badly for emerging market currencies with high interest rates as traders price in a narrower rate differential.

Other analysts, however, say that even with the Fed tightening rates, emerging market currencies could weather the effects as long as U.S. rate increases stay moderate and the earnings potential of investing elsewhere remains low in real terms. That should still facilitate the flow of funds back into emerging market regions, albeit at a slower pace than in 2003, and provide sufficient support for their currencies.

What could hurt these units is an abrupt spike in the fed funds rate, a scenario some in the market are not discounting, especially after Greenspan's upbeat comments last week.

For most of 2003, emerging market currencies were the star performers as investors bought them through carry plays to take advantage of their high interest rates. Carry trades involve borrowing in a low interest-rate currency like the dollar and lending in a high-yielding unit such as the Turkish lira.

With markets pricing in expectations that U.S. rates could increase less gradually than many had anticipated, carry trades involving emerging market currencies have started to unravel.

Higher U.S. short-term yields tend to raise the funding costs of these carry positions, causing investors to unwind the transaction or shift the funding leg of the trade to a currency with low yields.

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