The starting conditions are supportive for EM assets heading into 2021. It is not difficult to describe an environment going into 2021 that looks supportive for EM. Growth globally is forecast to pick-up from Q2 as the winter COVID-19 wave subsides and given a vaccine rollout most DM economies can normalize by H2. A reset of the international tone looks likely with a Biden Presidency which will have a less confrontational stance towards trade negotiations and will alter the mechanisms

through which the US and China deal with trade disagreements.

However, we expect EM FX will have more of a tactical role to play. An early-cycle growth environment typically heralds EM FX spot appreciation and currencies screen cheap on our longer-term models. This is worth a moderate tactical position in EM FX as we head into 2021, which we

express with an OW stance across all three regions. However, the bar still remains high for medium term, strategic FX allocations, in our view. EM FX carry remains historically low as central banks have eased policy in response to this crisis, fiscal and debt dynamics have deteriorated due to virus spending and a structurally higher EM-DM growth differential in the medium term seems unlikely as China continues to rebalance its economy. We therefore see the risk/reward for EM FX as unlikely to persuade asset allocators to engage in more strategic positions (see here). The combination of worsening government debt metrics that have steepened curves and central banks that have continued to cut rates this year (Turkey aside) means that buying EM local bonds FXhedged has not been this attractive for 7 years. That is where we expect strategic asset allocation to increasingly focus.

EMEA EM: Tempered enthusiasm; we enter the year with a moderate OW position (from MW). In a year with no shortage of misery, the EMEA EM region has stood out for an abundance of unfavourable idiosyncratic subplots within the major high yielding local markets. For 2021, our

view (and hope) is that an improving outlook for financial risk taking, buoyed by easy financial conditions and a “vaccine backstop,” will pave the way for an eventual economic recovery and a modest reflationary environment. In low yielding FX, consistent with a pro-cyclical theme, we increase our exposure to the more growth-sensitive currencies of the region. We do this by moving MW PLN (from UW), OW CZK (from MW). We enter a new UW in HUF, where higher growth is unlikely to alter a wellentrenched trend of depreciation. Meanwhile in high yielders, we position for risk premium compression. Alongside a more upbeat near-term outlook for commodity prices, we think Russian assets are poised to outperform, prompting us to keep hold of our OW RUB. The

fundamental outlook is more complex for Turkey and South Africa, where we remain MW in both, but we hold a number of outright trades looking for risk premium compression in Turkey. In South Africa, we enter a new short ZAR/RUB outright given expensive valuations for

ZAR. 

Latam: We expect a moderate rally into Q1-21 and then a slow depreciation thereafter to year end. LatAm FX has been among the underperformers YTD, with BRL, COP, PEN and even MXN ranking in the bottom 10 in total return terms, largely driven by their performance in Q1. However, from March onwards, relative performance improved considerably. We see the potential for a continued, albeit, moderate rally into Q1 as positive vaccine headlines prompt a reassessment of global growth in the context of inexpensive valuations in the region. We then envisage a slow grind weaker in LatAm FX to year end (alongside EM FX more broadly). The focus therefore is likely to move back to EM’s idiosyncratic issues which include, large and negative output gaps, low inflation, C/A

deterioration, fiscal/debt overhangs and rating downgrade risks all in the context of very low FX carry. These factors are all present in some form in LatAm FX, and will weigh on appreciation potential. We position with a small OW in the region by increasing our COP long versus CLP short whilst keeping a reduced long in MXN. We think this allocation has enough cyclical beta to perform into Q1. In our outright trades, we hold short CLP/COP and our short 2s6s USD/ARS NDF curve trade.