Emerging Markets: What has Changed

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

1) MSCI not only did not lift Taiwan and South Korea to major market status, it also took them off the review list

2) Banco de Mexico surprised markets with a 50 bp cut to 3.0%

3) The Brazilian central bank announced late on Friday that it would extend the FX intervention program beyond end-June, when it was scheduled to end

4) The latest poll (IBOPE) for the Brazilian presidential elections suggest a second round vote is becoming more likely

Over the last week, Brazil (+6.3%), Argentina (+5%), Vietnam (+4.1%) and India (+2.2%) have outperformed in the EM equity space in local currency terms, while Dubai (-5.2), Turkey (-0.3%) and Turkey (-0.3%) underperformed. 

In the EM local currency bond space, the most notable moves, in terms of yields, were Brazil (+11 bp), Colombia (+9 bp) and Turkey (+8 bp) underperforming, while Hungary (-18 bp) and Poland (-10 bp) outperformed. 

In the EM FX space, BRL (+1.3%), RUB (1%) MYR, IDR and THP (all about +0.5%) have outperformed over the last week, while HUF (-0.8% vs. EUR), MXN (-1%), and PEN (-0.5%) have underperformed.

1) MSCI not only did not lift Taiwan and South Korea to major market status, it also took them off the review list. It cited the lack of significant efforts to boost the convertibility of their respective currencies. Separately, MSCI decided not to include China's A-shares (mainland) in its global indices. It cited the quota system, which currently limits foreign ownership to 3% of the market cap. It also thought the ban against same day trading, the prohibition against the use of multiple brokers, and an uncertain tax environment are significant barriers. MSCI did say it will review its decision again next year. In the meantime, before the end of this month, it is expected to announce a stand-alone index for China A-shares that is not part of the EM index. 

2) Banco de Mexico surprised markets with a 50 bp cut to 3.0%. Not one analyst was looking for a cut. It noted Q1 was worse than expected, and that slack in the economy has increased. The bank also noted that domestic spending and investment remain weak, and has not been compensated by stronger exports. Lastly, the central bank said further rate cuts are not recommended but that's pretty much what they said after the March 2013 cut and then after the October 2013 cut.

3) The Brazilian central bank announced late on Friday that it would extend the FX intervention program beyond end-June, when it was scheduled to end. This is the second extension of the program (the first was in December) which started in August 2013. The decision is in line with our view that the FX swap program has become the bank’s preferred tool to manage FX. By managing (or micromanaging) the rollover rate of its swaps, the bank signals where they want the currency to go. We still think that USD/BRL stays within the 2.20-2.40 range, at least until after the presidential elections.

4) The latest poll (IBOPE) for the Brazilian presidential elections suggest a second round vote is becoming more likely. The results showed that Dilma’s government approval rating fell from 35% to 31% in May. Voting intentions now suggest that a second round is likely, since only 38% of those polled said they would vote for Dilma in the first round (down from 40%), which is about the same as the sum of voting intention towards the opposition parties. For a potential second round vote, Dilma’s support fell from 43% to 42%, while that of the main opposition candidate, Aercio Neves, rose from 24% to 33%. A lot rides on what will happen during the world cup. Several protests and strikes are scheduled already, and tensions are rising.