Emerging Markets: What Has Changed?

(From my colleague Dr. Win Thin)

This is what has changed in the EM space, in our view: 

1) The Bank of Israel surprised with a 25 bp rate cut Monday, an intra-meeting move

2) EUR/CZK traded above 26 for the first time since November 2011, as Q1 GDP came in much worse than expected at -1.9% y/y vs. -1.7% y/y in Q4

3) On the other hand, EUR/HUF moved lower on better than expected Q1 GDP of -0.9% y/y vs. -2.7% y/y in Q4

4) PBOC is finally fixing USD/CNY higher after a prolonged bout of appreciation

1) The Bank of Israel surprised with a 25 bp rate cut to 1.5% Monday, an intra-meeting move. Next scheduled meeting is May 27. We've been looking for more cuts, especially as the shekel has strengthened, but found this week’s cut a bit strange in terms of timing. Israel has kept rates steady since the December 24 cut to 1.75%. It met in January, February, and March and kept rates steady. Why now? The next meeting was only two weeks away. It looks like the currency aspect drove this decision. 

 As  it cut rates, the central bank noted that the shekel has been boosted by natural gas sales and global monetary easing, and announced a plan to buy $2.1 bln of foreign exchange this year in an effort to offset the money from gas sales. USD/ILS had already bottomed May 9 but we think the authorities are acting aggressively now to go WITH the market, instead of fighting it. The pair moved back above the 3.60 area for the first time since April 29. Resistance is seen near 3.70 and 3.75, support is seen near 3.60 and 3.56.

2) EUR/CZK traded above 26 for the first time since November 2011, as Q1 GDP came in much worse than expected at -1.9% y/y vs. -1.7% y/y in Q4. In q/q terms, GDP was -0.8% vs. -0.2% in Q4 and we note that GDP has contracted q/q for 6 straight quarters. Indeed, the Q1 reading of -0.8% is the worst of them all. Things are getting worse, not better. If market keeps selling CZK, the central bank may not have to do anything. The November 2011 high near 26.12 isn't very far away, and we favor a move towards late 2009 highs near 26.50. For now, the market is doing the heavy lifting for the central bank.

3) On the other hand, EUR/HUF is moving lower on better than expected Q1 GDP of -0.9% y/y vs. -2.7% y/y in Q4. In q/q terms, Q1 GDP grew 0.7% vs. a revised -0.4% (was -0.9%) in Q4. It is the first positive q/q reading since Q4 2011 and the strongest since Q1 2011. Still, this is hardly any reason to break out the tokaj to celebrate, and it is certainly not strong enough to preclude another 25 bp rate cut at the next meeting May 28. 

We think that current levels near 290 would be a good opportunity to go long EUR/HUF. 200-day MA comes in near 290 and should offer support. Break below would target support near 285. On the upside, resistance is seen near 295, 300, and 303. Separately, we note that the recent weakness of the Swiss franc may be supportive of Hungary insofar as it is easier to service the still substantial levels of franc denominated consumer debt.  

4) PBOC is finally fixing USD/CNY higher. After a long string of CNY gains, it has finally started to weaken in line with the rest of the region. For 4 out of the 5 past days, USD/CNY has been fixed higher, and the Thursday fix was the highest since May 6. Next week will give markets the first glimpse of May data from China, with the HSBC flash manufacturing PMI due out next Wednesday. April data was mixed, with surveys (PMIs) weaker than expected and hard data (trade, new loans) stronger than expected. 

We think that China data probably offers modest downside risks to markets rather than upside risks at this juncture. Between the broad based dollar rally under way and downside risks to the Chinese economy, we think that the yuan is likely to trade sideways to weaker in the coming weeks. Next week, we get the first glimpse of the economy with HSBC flash PMI on Thursday.