Research Team at Goldman Sachs, suggests that while the oil and China weakness pushed EM FX lower to start the year but in the medium term, EM FX is entering undervaluation territory.
"The first three weeks of January saw a broad-based sell-off in EM currencies, which has reversed recently. Two factors were driving the price action: uncertainty surrounding the China (and CNY) outlook and volatility in oil prices. Looking forward into the medium term, a combination of EM FX valuation and carry has moved into a supportive zone for the first time in several years. The key market debate is thus whether the associated expected returns outweigh the elevated uncertainty that currently prevails.
China-exposed currencies, non-oil commodity producers to underperform; more constructive on RUB, MXN, PLN, INR: We forecast further depreciation in places exposed to China's slowdown and currency shifts and like selected $/NJA longs (MYR, THB, KRW). We expect metals to underperform oil during 2016H2 and 2017 and see further downside to ZAR, CLP and PEN. As oil market volatility in 2016H1 gives way to a new higher equilibrium price in H2, the RUB and MXN (with supportive valuations) should benefit. We are also relatively constructive on the EUR/PLN and INR, where external balances and growth are strong.
Still positive on the Dollar despite market pressure: The recent sharp decline in market sentiment has put the USD under pressure. Market worries include the possibility of a US recession, devaluations in the CNY and the impotence of the ECB and BoJ in their fight against low inflation. We push back on these market views. We continue to expect healthy US growth leading to Fed rate hikes, only a modest weakening of the CNY and both the ECB and BoJ to remain committed to their inflation target and to ease further. We continue to expect EUR/$ at 0.95 and $/JPY at 130 in 12 months."