EM Preivew for the Week Ahead

(from my colleague Dr. Win Thin)

There are several central banks from the emerging markets that meet this week, but none are expected to change policy.    In addition, the market will be watching Chinese data and Brazil's inflation. 

China data deluge for April starts this week, with trade next up on either Tuesday or Wednesday. Export growth is seen easing to 9% y/y from 10% y/y while import growth is seen slowing from 14.1% y/y to 13% y/y. CPI and PPI are due out on Thursday, with the former seen rising to 2.3% y/y from 2.1% y/y in March but the latter easing to -2.3% y/y from -1.9% y/y in March. New loans could come out near the end of this week, expected at CNY767.5 bln vs. CNY1.06 trln in March. 

Weak China data continues to be reported. April HSBC services PMI was reported earlier today at 51.1 vs. 54.3. Last week, official manufacturing April PMI was reported at 50.6 vs. consensus 50.7 and 50.9 actual in March, while HSBC final manufacturing April PMI was reported at 50.4 vs. 50.5 consensus and 51.6 final in March. We continue to believe that China growth will stabilize around the 8% level, but the risks are tilted more towards 7.5-8.0% than 8.0-8.5%. A slowdown below 7.5% would probably lead to another round of stimulus by China.

The Chinese yuan posted its biggest decline of the year today. We think the recent bout of excessive yuan strength is over for now. Over the weekend, the State Administration of Foreign Exchange (SAFE) announced new regulators that will curb the banking system's ability to short the US dollar (or other currencies, for that matter). Specifically, the quota for individual banks to short foreign currencies linked to their currency loan and deposit situation will be strictly enforced. Banks are given until the end of next month to comply. Previously, SAFE simply set the quotas. 

Essentially, the Chinese banking system is seen as having more foreign currency loans (short) than deposits (long). This would imply a need by local banks to buy foreign currencies, especially the dollar. The dollar has fallen 1.5% against the yuan since late February, a pace that we viewed as unsustainable. This policy shift from SAFE likely signals the end to the recent move that has seen the dollar drop to 19-year lows against the yuan.

The Russian central bank holds a policy meeting this week, with no change in policy expected. However, with inflation easing and growth slowing, recent official comments suggest an easing cycle could begin in H2. Indeed, President Putin has called on his government to submit plans for stimulus. Earlier this year, the central bank lowered the Lombard rate and we think that was a precursor to cuts in the more important refi rate ahead. Inflation remains above the desired 5-6% range, and is expected at 7.2% y/y in April when it is reported later this week.

The Polish central bank holds a policy meeting Wednesday, with no change in policy expected. Officials have signaled a pause in Q2 after cutting 50 bp in March, but data continue to come in weak. We believe the easing cycle will resume by mid-year, with another 50-75 bp of easing possible by year-end. Policy rate currently stands at 3.25%, while inflation is 1% y/y and has been below the 1-3% target range for two straight months. Real rates remain too high given the depths of the slowdown.

The Malaysian central bank holds a policy meeting Thursday, with no change in policy expected. However, the economy is at risk as exports are contracting and growth is slowing. IP contracted -4.5% y/y in February, the biggest contraction since mid-2011. With the election out of the way, Malaysian assets are rallying but we think a stronger ringgit is not particularly desirable right now. There is fiscal stimulus in the pipeline from ahead of the elections, but may be pared back a bit now. We think the bank will remain on hold in 2013, but will depend on growth staying fairly robust. There are clearly downside risks to global growth, and so there is a risk of a dovish bias developing at the central bank.

The Korean central bank holds a policy meeting Thursday, with no change in policy expected. Of the EM central banks meeting this week, however, we think Korea offers the most chance of a dovish surprise. Inflation was 1.2% y/y in April, a cycle low and below the 2-4% target for six straight months. Yet the BOK has been on hold at 2.75% for seven straight months. Furthermore, the strong won is providing more headwinds for the economy. JPY/KRW is making new lows, and has seen a pretty big move from over 15 in 2012 to around 11 now. We think more actions will be taken to prevent won gains, which would include a surprise rate cut.

The Peruvian central bank holds policy meeting Thursday, with no change in policy expected. However, expectations are building for a start to the easing cycle ahead, perhaps in early Q3. The economy is showing signs of weakness, with GDP growth slowing to 5% y/y in February. Q1 growth is tracking near 5.5% y/y, down from 6% y/y in Q4 and this would be the slowest pace since Q4 2011. CPI inflation eased to 2.3% y/y in April, the slowest since February 2011 and near the center of the 1-3% target range. Lower copper and gold prices are having an impact too, with exports contracting -21% y/y in February, continuing a string of weak readings.

Brazil IPCA inflation for April will be reported Wednesday, and is expected to ease from 6.59% y/y to 6.42% y/y. The real continues to underperform within EM on concerns about inflation and the lack of a stronger policy response. As such, lower inflation could go a long way in helping the real catch up with the rest of EM FX. Next COPOM meeting is May 28/29, and we think the central bank will have to engage in some damage control if Brazil assets remain under pressure toward the end of this month. The Bovespa is one of the worst performers in EM at down 10% YTD, while the real continues to have trouble breaking below 2.00.