Emerging Market Preview: Fundamental Headwinds

(from my colleagues Dr. Win Thin and Ilan Solot)

EM countries are facing serious growth headwinds that favor more monetary easing ahead. Fortunately, most countries are experiencing disinflation, and that should allow for more rate cuts in the coming months. Hungary, Israel, and Thailand all cut rates last week. The one glaring exception was Brazil, where the central bank hiked last week by a larger than expected 50 bp. 

This week, Poland is expected to cut rates again while Mexico is seen on hold for now. Most EM currencies remain under pressure. With the pace no longer measured and controlled, we believe policymakers are starting to think about intervention to prevent excessive currency weakness. We already had two interventions Friday, with one verbal (Turkey) and one actual (Brazil). More are likely to follow if disorderly conditions persist.

The Turkish government's poor response to protests over a local development project that would have uprooted dozens of trees needlessly aggravated its political situation. This seemed to be last straw of a number of simmering grievances, including developmental projects that rode roughshod over local views, new restrictions on the consumption and sale of alcohol, and the government's controversial support for opposition groups in Syria.  I

t looks as if the situation is set to get worse before it gets better. Recent news reports suggest that Turkey's Public Workers Unions Confederation (KESK), with 240,000 members in 11 unions, would hold a "warning strike" on June 4-5 to protest at a crackdown on anti-government protests over the last four days.

We highlighted deteriorating Turkish fundamentals weeks ago, and the trend continues. CPI inflation spiked to 6.5% y/y in May from 6.1% y/y in April, and remains near the top of the 3-7% target range. Base effects for June and July 2012 are low, and so the y/y rate is likely to move higher near-term before high base effects for August-October help to lower it. Core inflation also moved higher in May to 5.6% y/y from 5.4% y/y in April. Next policy meeting is June 18, and after two straight months of dovish surprises, we think it will keep policy on hold. 

The problems with Turkey’s fundamentals don’t stop with high inflation. The external accounts have worsened significantly, with April trade deficit much worse than expected and the 12-month total rising to -$88.8 bln, the highest since August 2012. Unlike Brazil, Turkey attracts little in the way of FDI and so must rely on short-term “hot” money to finance its current account gap. The gap is expected to widen this year back to near -7% of GDP from around -6% in 2012, but given the recent deterioration, we think there is quite a bit of risk that this gap comes in much wider. That the external accounts are worsening despite sluggish growth is all the more disappointing. GDP growth decelerated to 1.4% y/y in Q4 from 1.6% y/y in Q3, and is the slowest since Q3 2009. 

Monthly data for Q1 suggests little improvement in overall GDP growth, which is why the central bank has continued to cut rates aggressively despite inflation being above the 5% target. If and when growth finally does pick up, the current account gap will widen even more.

Brazil May trade data will be reported later today, with exports expected at -5% y/y and imports basically flat. External accounts have been worsening recently, not yet to alarming levels but worth keeping an eye on. COPOM minutes from the May 28/29 meeting are due out Thursday. This will be followed by May IPCA inflation report on Friday, and is expected to remain steady at 6.5% y/y. With inflation remaining at the top of the 2.5-6.5% target range, we think the tightening will continue at the next meeting July 9/10. The central bank finally intervened Friday with swaps as USD/BRL tested 2.15, but the effect was fleeting as the pair continues to trade near that high from Friday. Long-term charts point to a test of the March 2009 high near 2.45, though resistance seen near 2.20. Support seen near 2.10 and then 2.00.

Polish central bank meets Wednesday, and is expected to cut rates 25 bp to 2.75%. May PMI was reported today at 48.0, below the 50 boom/bust level for the fourteenth straight month. The real sector data continue to come in weak, and the pause in the easing cycle lasted only one month. We think is scope for rates to fall to 2.5% or lower, as CPI inflation of 0.8% y/y is well below the 1.5-3.5% target range. EUR/PLN has moved into a higher trading range, and the recent break of the 4.28 area targets the June 2012 high near 4.43. Some resistance seen near 4.30 and 4.35, while support seen near 4.25 and then 4.20.

Mexico central bank meets Friday, and is expected to keep rates steady at 4.0%. Before the decision, Mexico will report May CPI data. Consensus is for headline inflation to remain high at 4.7% y/y, which is why we think the central bank will hold off on easing near-term. If the data remain weak in H2, we think there is scope for easing but not until inflation has moved back into the 2-4% target range. Later today, IMEF PMI report for May will be reported. For USD/MXN, break of the 12.95 retracement objective would target the 13.25 area but there is strong resistance in the 13.00 area. Support seen near 12.70 (200-day MA) and then 12.60.

Hungary reports April retail sales on Wednesday, and April trade and IP on Friday. Today, May PMI was reported at 47.1 vs. 51.5 in April and moved back below 50 for the first time since December. Recently, central bankers have suggested that there is still room for easing. We concur, given low inflation and ongoing recession. EUR/HUF has performed better than one might expect given all the negative cross-currents, both domestic and external. We do think the currency pair will have trouble sustaining moves below 290, and look for a move higher. Resistance seen near 300 and 305, support seen near 290 and 285.

Czech Republic reports April retail sales on Wednesday, April trade on Thursday, and April construction and industrial output on Friday. Here too, the data continue to worsen but the market is doing the central bank’s job of easing by selling the koruna earlier this year. We think EUR/CZK has fallen too much since mid-May, and think that further koruna weakness is warranted. Strong support seen near 25.60, and we look for a move back to the 26.20 high from May 21.

Taiwan reports May trade on Friday, and will be the next major country to report after Korea and Brazil. Korea reported stronger than expected exports but much weaker than expected imports, and so we look for Brazil and Korea to provide a clearer picture of the trade trends. The Taiwan economy remains under pressure, with May PMI falling to 47.1 from 50.7 in April. This is the first reading below 50 since November 2012. USD/TWD seeing resistance near 30.0, but we look for a test of July 2012 high near 30.20. Support seen near 29.80 and then 29.60.

Chile reports May trade on Friday as well. It will also report May CPI on Friday, and is expected to remain low at 1.1% y/y vs. 1.0% y/y in April. With inflation well below the 2-4% target range, we do think the table is set for easing in H2. Real sector data has been mixed, with exports and IP weak and consumption coming in strong. Weakness in the peso will be welcomed, and could lead the central bank to hold off on easing near-term. For USD/CLP, break of the 501 retracement objective now targets the June 2012 high near 523. Some resistance seen near 510, support seen near 500 and then 490.