As US Federal Reserve tapers, don't count out emerging market currencies

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Market participants will likely return to the emerging market world by buying the more solid fundamental names with attractive valuations and higher interest rates. Market participants will likely return to the emerging market world by buying the more solid fundamental names with attractive valuations and higher interest rates.
SummaryNow, many investors are convinced Fed's tapering won't cause that kind of market volatility again.

its strong trade relationship with the world's largest economy.

One-year volatility on the Mexican peso has dropped to 12.1 percent on Friday from highs of 15.02 percent in early September. The Mexican peso's volatility has become a barometer of risk for emerging market currencies because of the breadth of that market.

PRESSURE FOR SOME EMERGING MARKETS

Countries that have to import capital to finance domestic spending such as South Africa and India could see their exchange rates suffer, while those with surpluses such as Mexico won't feel as much of a pinch.

In Mexico's case, not only do investors think its economy is fundamentally sound, its assets have higher returns as well. Mexico's 10-year government bonds yield 6.33 percent, compared to the U.S. ten-year note of 2.92 percent.

The Mexican peso, meanwhile, is 5 percent undervalued against the dollar, according to Commerzbank researchers.

From a developed market-perspective, Mexico can give you stable returns, without having to incur a lot of risk, said Mario Robles, director and head of Latin American research at Commerzbank in New York.

Swell said Goldman has added emerging market debt - both local currency as well as in dollar, with an emphasis on Latin America. "Latin America has underperformed both from a rate perspective and currency perspective."

Some fund managers have cited Brazil's currency and debt as value plays in the midst of the Fed's tapering. The Brazilian real has fallen nearly 14 percent this year, and some fund managers think it will stabilize in 2014.

The U.S. dollar is currently trading at 2.36 reals, and Standish Asset Management thinks despite the tapering, the greenback will be contained within the 2.20-2.40 trading band.

"We think the Brazilian real is fairly valued," said Federico Garcia Zamora, director of currency strategies and senior portfolio manager at Standish Asset Management in Boston, which oversees assets of about $163 billion.

He noted Brazil's returns of between 10-12 percent on short-term bonds with maturities ranging from one to three years. This allows investors borrowing in lower-yielding currencies more "carry trade cushion," and the selloff in the real makes it a more attractive time to put on such trades.

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