Emerging Markets: What has Changed

(from my colleague, Dr. Win Thin)

1) The annexation of Crimea by Russia represents an important escalation of the crisis

2) China has re-emerged as a concern for markets

3) Turkish political tensions are rising again ahead of March 30 local elections

4) Brazil consumer inflation is accelerating, making central bank decisions more difficult going forward

5) Thai government may end the state of emergency early

Over the last week, Egypt (+2.4%), Thailand (+1.4%), and India (+1.2%) have outperformed in the EM equity space in local currency terms, while Russia (-6.5%), Hungary (-5.7%), and Hong Kong (-4.2%) have underperformed.

In the EM local currency bond space, Philippines (10-year yield -12 bp), Israel (-10 bp), and Chile (-6 bp) have outperformed over the last week, while Ukraine (10-year yield +87 bp), Russia (+62 bp), and Turkey (+54 bp) have underperformed.

In the EM FX space, PKR (+5.5% vs. USD) and IDR (+0.8%) have outperformed over the last week, while CLP (-2.2%), TRY (-1.8%), and ZAR (-1.1%) have underperformed.

1) The annexation of Crimea by Russia represents an important escalation of the crisis. The Crimean crisis threatens to escalate further. After the Crimean Parliament last week approved re-joining Russia, it will be presented as a referendum to the people of Crimea this weekend. The West continues to take limited action, as the OECD today suspended Russia’s accession process. EU officials meet March 17 to consider asset freezes and travel bans on Russian officials. German Chancellor Merkel appears to be taking a harder line on Russia than previously thought, so the EU could deliver some surprises. The ruble, Russian stocks and bonds remain under pressure. The MICEX is making new lows for this move near 1250, while 10-year Russian government bond yields are making new highs near 9.5%.

2) China has re-emerged as a concern for markets. The poor February trade reading and weaker than expected new loans, IP, and retail sales data, coupled with the softer CPI, may encourage the view that the yuan is overvalued and that Chinese officials have scope to ease policy to help facilitate the transition it is trying to engineer. The persistent yuan appreciation that helps take the edge of imported inflation seems less necessary now. In turn, a weaker yuan is consistent with apparent efforts to introduce greater volatility to deter hot money inflows (which are often disguised Chinese flows themselves) and to chip away at the larger moral hazard issues that permeates the financial sector. 

3) Turkish political tensions are rising again ahead of March 30 local elections. The funeral for a child that died this week after being injured in the June 2013 Gezi Park protests turned into another large-scale anti-government demonstration. While the lira has stabilized, Turkish government bonds and stocks remain under pressure. The yield on the 10-year government bond rose this week above 11%, the highest since 2010, while the Istanbul-100 index remains near this year’s low near 60000. 

4) Brazil consumer inflation is accelerating, making central bank decisions more difficult going forward. Both FIPE and IPCA measures accelerated in February after a steady run of deceleration. Markets should not be too surprised to see further upside, as inflation at the producer and wholesale level had already been accelerating since late 2013. Furthermore, there are upside inflation risks stemming from potential hikes in administered electricity prices this year. BCB is widely expected to deliver another 25 bp hike to 11% on April 2. We think it would like to end the tightening cycle then, but may not be able to if current inflation trends continue. Next meeting after that is May 28.

5) The Thai government said it may end the state of emergency before it expires March 23. Nation police chief cited in improving political situation, but we would not get too bullish on this news. Nothing has really changed, nor has anything been resolved since both sides have not given an inch. Street protests may have calmed, but the underlying tensions remain in place and will likely erupt at another time. Meanwhile, the Bank of Thailand cut rates 25 bp to 2.0%, as expected. The economy continues to suffer from the political paralysis, and further easing is likely this year.