Emerging Markets: What Has Changed

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

Brazilian central bank sounds more hawkish; Moody’s sounds more bearish

 Bank of Israel will increase its dollar purchases to $3.5 bln in 2014

The Colombian central bank reduced its dollar purchase program

Price action this week: Brazil (-2%), Chile (-2%), and Singapore (-1.5%) have underperformed in the EM equity space in local currency terms, while Israel (+1%) and Taiwan (+2%) have outperformed. China markets have been closed most of this week due to a holiday. In the EM local currency bond space, Hungary (10-year yield up 4 bp) Philippines (up 7 bp) have underperformed over the last week, while India (10-year yield down 9 bp), Brazil (down 5 bp) have outperformed. In the EM FX space, IDR (-3%) and MXN (-1%) have underperformed vs. USD over the last week, while HUF (+2%) and BRL (+2%) have outperformed.

1) Brazilian central bank sounds more hawkish; Moody’s sounds more bearish. The BCB’s inflation report, along with subsequent comments by Tombini, provided further fuel to the view that the SELIC rate may rise to 10% or above. Our base case is still for a pause at 9.75%, with a high risk of higher rates later on. The hawkish rhetoric, slightly better inflation numbers recently, and a more stable BRL may be enough to contain inflation expectations and allow for the pause. Separately, Moody’s changed its outlook on Brazil’s rating (Baa2) from positive to stable. The agency cited deteriorating debt ratios as a major factor and was skeptic that the economic recovery will be strong enough to turn these ratios around. Our internal model is still more negative than that (we have Brazil at BBB-/Baa3/BBB-), and is more in line with S&P’s move in June to change the outlook (BBB) from stable to negative.

2) Bank of Israel will increase its dollar purchases to $3.5 bln in 2014 from $2.1 bln in 2013. Purchases are meant to offset exchange rate impact of dollar inflows from natural gas production. The bank also noted that "As in the past, the Bank of Israel will continue to operate in the foreign exchange market in situations of exchange rate fluctuations which are not in line with fundamental economic conditions or when the foreign exchange market is disorderly." We also note that Netanyahu is taking a more hard-line response to what appears to be a less hard-line stance by Iran's new president. For USD/ILS, support seen near 3.50, resistance seen near 3.55 and then 3.60.

3) The Colombian central bank reduced its dollar purchase program. At its meeting last Friday, the bank decided to slow purchases to “no more than” $1 bln from October to December. Recall that the bank’s previous policy was to buy at least $2.5 bln between June and September. The move had a positive impact in the peso, of course, which has gained 1.3% against the dollar since then. In addition, the central bank statement sounded significantly more hawkish than previous official communications, but in line with recent supportive data. The bank will probably remain on hold for the foreseeable future, forcing those who have been pricing in a risk of another cut looking to think again.