JPMorgan strategists downgraded the bank's view on emerging market currencies from "overweight" to "neutral" on Monday, stating that short-term positions have become "overbought" following a year-long robust rally.
The view from this US investment bank is closely watched by traders. JPMorgan also downgraded the South African rand's rating from "overweight" to "neutral," having reduced exposure to Central and Eastern European currencies the previous week and adjusted its outlook on the Mexican peso.
"In some instances, it's necessary to reduce short-term risk due to excessively crowded positioning, and in our view, now is one of those moments," JPMorgan strategists wrote in a client note.
Despite volatility stemming from US trade tariffs, international investors rediscovered their interest in emerging market assets last year. Attractive interest rates, more compelling asset valuations, and a nearly 10% decline in the US dollar further propelled the capital inflow.
This influx has driven the MSCI Emerging Market Currency Index up by approximately 7.5% over the past 12 months, pushed returns on emerging market local currency bonds close to 20%, and sent the MSCI Emerging Market Equity Index soaring by nearly 40%.
JPMorgan analysts stated that the renewed flow of funds into emerging markets since the start of the year has pushed the bank's internal emerging market foreign exchange risk appetite index deep into overbought territory, significantly above the threshold that triggers a "sell signal."
"We have repeatedly alerted investors to the growing positioning in emerging market currencies, and this is sufficient for us to opt for taking short-term profits," they added.
Analysts also pointed out that, since the beginning of the year, emerging markets have had to contend with "a series of other noise," ranging from issues related to Venezuela and Iran, Federal Reserve independence, US Supreme Court rulings, to the new tariff threats now emerging concerning Greenland.
While these developments are not the primary drivers behind JPMorgan's adjustment of its emerging market FX view, the bank's analysts noted that these key areas of concern could begin to influence each other.
"We often observe that once market positioning becomes excessively extended, it becomes more sensitive to news that might otherwise be downplayed. Given the current low starting points for both global volatility and risk premiums, this tension could manifest as a near-term pullback," they said.
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