Emerging Markets: What has Changed

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

1) Recent headlines suggest that Russia and China have managed to sign the estimated $440 bln gas deal

2) Protests and strikes are heating up the political landscape in Brazil

3) The Thai army has assumed power in a coup after the main political parties were unable to reach a negotiated solution to the current situation

4) The election results in India surpass even the most optimistic forecasts. Early vote counts give Modi, and his BJP party alone, enough votes to win a simple majority

5) Central Bank of Turkey surprised markets with a 50 bp cut in the main policy rate

Over the last week, Argentina (+7.0%), Hungary (+4.6%), and Turkey (+3.3) have outperformed in the EM equity space in local currency terms, while Brazil (-2.4%), Chile (-1.0%), and Peru (-1.0%) have underperformed. 

In the EM local currency bond space, Ukraine (10-year yield -67 bp), Turkey (-24 bp), and Russia (-20 bp) have outperformed over the last week, while Hungary (10-year yield +20 bp), Thailand (+19 bp), and Indonesia (+7 bp) have underperformed. To put this in better context, the 10-year UST yield was up 5 bp over the past week.

In the EM FX space, RUB (+1.5% vs. USD), INR (+1.4), and COP (+1.1%) and have outperformed over the last week, while ILS (-0.8%), EGP (-0.2%), and PKR (-0.2%) have underperformed.

1) Recent headlines suggest that Russia and China have managed to sign the estimated $440 bln gas deal. The gas price for the deal is not yet known, but it is expected to come below the average price that Russia exports to Europe ($380.50 per thousand cubic meters). The plan is to build a $22 bln pipeline connecting the two countries. This is a big symbolic victory for Russia, coming at a moment when it is become increasing isolated from the West. Still, the amount of gas exports foreseen in the deal amount to about one-fifth of what Russia exports to Europe. Also note that natural gas represents about 60% of Russia’s total exports. 

2) Protests and strikes are heating up the political landscape in Brazil. Currently, parts of the police force in Rio are in strike, as are bus drivers in the state of Sao Paulo for the third day now. More worrying for the government, unions and social movement groups are starting to plan protest during the world cup. In fact, a report by a local news source suggests they are already scheduling four protests, the first set to coincide during the opening ceremony. There is an electoral poll (IBOPE) scheduled to be released today, which may prove a market moving event.

3) The Thai army has assumed power in a coup after the main political parties were unable to reach a negotiated solution to the current situation. The coup can’t be much of a surprise after the army imposed martial law earlier this week. The baht weakened and Thai government bonds sold off initially. The situation remains fluid, but we suspect that the coup will eventually be seen as a positive development since it signals an end to the political deadlock. Indeed, the military became increasingly seen as the only possible solution after years of the deepening divide in the country. This should be the beginning of the end of the long period of uncertainty in Thai politics, but we think the move back to a civilian government is likely to take much longer than usual. For now, we have softened our negative bias on Thai assets but remain on the sidelines until the end game becomes clearer.

4) The election results in India surpass even the most optimistic forecasts, as Modi and his BJP party alone won a majority in parliament. This means the BJP will not have to rely on coalition partners to push through structural reforms. Having been bullish on India since Rajan took the reins of the central bank, we are as excited as everyone else about the possibility of a structural change in India – “possibility” being the operative word. The big question for markets in India is how much of the good news is priced in. In short, we think the rally has more to run over the medium term. We expect Indian assets to trade with a positive bias from this point on, but until some actual measures are seen, they are unlikely to reproduce the magnitude of outperformance seen over the last few months.

5) Central Bank of Turkey surprised markets with a 50 bp cut in the main 1-week repo rate to 9.5%. Even the most dovish of calls was for a cut in the ceiling of the rates corridor, which remains at 8-12%. Policy statement highlighted declining uncertainties and improving risk premium indicators as reasons for the cut. It added that policy remains tight even after the cut, and that this stance will be maintained until there is a significant improvement in the inflation outlook. The lira and Turkish bonds have rallied after the move, helped in part by generally positive sentiment on EM. Real rates on 10-yaer bonds are now negative, and the next CPI print on June 3 could be a rude awakening for Turkish policymakers.