What has Changed in the Emerigng Markets?

(from my colleague Ilan Solot )

1) The Bank of Korea is becoming more independent

2) We expect the Brazilian Central Bank to start hiking by 25 bp in May

3) Israel intervened to weaken the shekel for the first time since July 2011

4) Chile is stepping up its FX intervention rhetoric

5) Mexico suspends USD auctions to prevent peso weakness

1) The Bank of Korea is becoming more independent. The BOK left rates unchanged at 2.75% as we had expected, but contrary to consensus expectations pricing in a 25 bp cut. We think there are three factors which underpinned the decision, and which markets may have incorrectly underweighted: (1) A more measured approach to monetary easing makes sense in light of the upcoming fiscal stimulus; (2) KRW is down nearly 6% YTD against the dollar already; (3) growing BOK independence. As many observers have already pointed out, there are signs that the BOK is trying to distance itself from the Blue House. For example, the Finance Minister is no longer attending BOK meetings, and Governor Kim reportedly did not attend a traditional high profile policymaking breakfast at the Blue House last Friday. 

 2) We expect the Brazilian Central Bank to start hiking by 25 bp in May. However, it will be a close call and we assign a 33% probability for a 25 bp hike in April. There are three factors that underpin our decision: (1) Government measures: If the BCB was about to start the tightening cycle in April, why would the government go through the trouble to implement all these measures and weakening its fiscal accounts? (2) March IPCA was inconclusive: The much awaited March inflation report was inconclusive, but on balance may take out some of the urgency to hike. (3) BRL: A stronger real can only play in favor of delaying the hikes. Even though we think they will defend the 1.95 level for now, the move below the 2.00 level against the dollar, if sustained, can take some steam out of inflationary pressures.

3) Israel intervened to weaken the shekel for the first time since July 2011. The shekel was making new highs against the dollar before the central bank intervention, which drove USD/ILS back near 3.65 from below 3.60. We think Israel is only trying to lean against the wind, and do not expect more aggressive Brazil-type measures. The central bank has been on hold at 1.75% since the last 25 bp cut on December 24, but further shekel gains could be a factor behind another rate cut. As a small open economy, a strong currency acts like monetary tightening and so a rate cut would work to offset this effect. Since December 24, ILS is one of the best performers in EM, up 3% vs. USD. Governor Fischer steps down at the end of June, so it will be interesting to see if his replacement will have a different strategy with regards to the exchange rate and interest rates. 

4) Chile is stepping up its FX intervention rhetoric. Finance minister Larrain made some ominous comments about currency wars and peso strength, noting that “intervention in currency markets is an option.” We have been warned, again. We think the bar is high for taking action but the problem is that when it happens, it tends to be large. Given the already solid performance of the CLP year to date, the risk reward is gradually shifting. We expect growing residence as we approach the 460 level (about 2.0% away). The 465 level is thought to have triggered the last dollar purchase plan back in January 2011.

5) Mexico suspends USD auctions to prevent peso weakness. Since late 2011, the mechanism required the bank to conduct a $400 mln auction whenever the peso weakened by 2.0% or more. It’s hard not to interpret this as a subtle way of expressing discomfort with the outperformance of the peso. On the other hand, it was seldom used and did act as a circuit breaker when the FX market got disorderly. We do not expect any sort of dollar accumulation program yet, but we wonder if some jawboning could begin if we threaten to break below the 11.50 area.