Emerigng Markets: What has Changed

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

1) There has been a lot of conjecture about the PBOC’s intentions with the RMB 500 bln injection

2) Turkish President Erdogan threatened to cut ties with rating agencies

3) S&P reclassified Greece as an Emerging Market

4) Ukraine’s parliament approved a law giving special status to two eastern regions, suggesting that the situation (while still tense) may start to cool a bit

5) The most important development from the last Brazil presidential poll in Brazil was not Marina’s gain in voter’s preference, but Aecio’s gain

6) Colombian central bank minutes showed a growing likelihood that the tightening cycle may have ended

(7) SARB Governor Marcus announced that she is stepping down

Over the last week, Argentina (+3.0%), Korea (+1.6%), and Israel (1.6%) have outperformed in the EM equity space as measured by MSCI, while Brazil (-2.5%), Russia (-2.4%), and Hong Kong (-2.2%) have underperformed. To put this in better context, MSCI EM fell -1.3% over the past week while MSCI DM was flat.

In the EM local currency bond space, Russia (10-year yield -14 bp), Korea (-6 bp), and the Philippines (-6 bp) have outperformed over the last week, while Turkey (10-year yield +28 bp), Poland (+20 bp), and Brazil (+19 bp) have underperformed. To put this in better context, the 10-year UST yield was up 7 bp over the past week.

In the EM FX space, HUF (+0.7% vs. EUR), CZK (+0.3% vs. EUR), and COP (+0.2% vs. USD) have outperformed over the last week, while BRL (-3.0% vs. USD), RUB (-2.4% vs. USD), and TRY (-1.4% vs. USD) have underperformed.

1) There has been a lot of conjecture about the PBOC’s intentions with the RMB 500 bln injection. Perhaps the mystery relates to the fact that the rates for the operation were not disclosed and no major announcement was made. We don’t read much into this omission, which seems in line with recent targeted (as opposed to large scale) style of stimulus. But it does reduce the chance of a RRR cut. For us, the move was motivated by three factors: (1) recent weak data, (2) upcoming golden week holiday; (3) IPOs in the pipeline (around 10 expected for next week), which could divert liquidity away from other forms of lending and the equity markets. On the margin, we also note that the stronger CNY over the last several months represents some tightening. The CNY is up 2% against the USD since the April peak, but nearly 9% stronger against the EUR (the EU is China’s largest trading partner).

2) Turkish President Erdogan threatened to cut ties with rating agencies. The backlash against rating agencies reportedly happened after Fitch included the country on a list of those most exposed to downgrades. Fitch now rates Turkey at BBB-, which is the lowest level of investment grade, and our own rating model points to imminent downgrade risks. Erdogan’s threat is obviously not a good idea for a country that is so dependent on foreign capital flows. Turkey has a -6.3% of GDP current account deficit, and bank borrowing is running around 38% of GDP, or $164 bln, which compares with its FX reserves of $113 bln.

3) S&P reclassified Greece as an Emerging Market. Greece loses its developed market status but the move is not a big surprise since this follows a similar move by MSCI for Greece. S&P also moved Qatar and UAE up to EM from Frontier status, and also matches earlier moves by MSCI for both countries.

4) Ukraine’s parliament approved a law giving special status to two eastern regions, suggesting that the situation (while still tense) may start to cool a bit. Still, it didn’t prevent the ruble from making new all-time lows again, both vs. USD and the basket. Falling commodity prices aren't helping sentiment either. The central bank held off on tightening last week but may be forced into doing so soon if the currency continues its free fall.

5) The most important development from the last Brazil presidential poll in Brazil was not Marina’s gain in voter’s preference, but Aecio’s gain. The IBOPE poll proved the rumors true and showed Marina (43%) widening her lead against Dilma (40%) in the second round. But also, Aecio rose to 19% from 15% in the first round and to 37% from 33% in the second round against Dilma. As we had noted in a previous report, the Petrobras scandal could change the dynamics of the race since it could inspire Aecio to try a comeback. Markets may see this as a positive development, since they still prefer an Aecio victory, but this is a misguided view. This would mean that Aecio would have to greatly step up the attacks against Marina to have a chance, and would make a 2nd round alliance with her more difficult. It’s still too early to discuss this in depth, but let’s just say that the tail risks have increased.

6) Colombian central bank minutes showed a growing likelihood that the tightening cycle may have ended. Some voted to hold rates steady at the August meeting, though a majority pushed through a 25 bp hike to 4.5%. Data this week showed a marked slowing in the economy, and suggests steady rates are likely at the next meeting on September 26. In related news, Finance Minister Cardenas said he’s “very comfortable” with the current peso exchange rate, adding that it is near its equilibrium level. He also added that he wouldn’t mind if the peso fell further but that he would be in favor of paring the country’s dollar purchases if peso weakness is sustained for a “prolonged period of time.”

(7) SARB Governor Marcus announced that she is stepping down. Marcus has been governor since November 2009, with one term of 5 years. She was the first woman to hold this top post. Previous Governor Mboweni, held two terms (1999-2009), as did Governor Stals (1989-1999) before him. We are not sure why Marcus did not renew her contract for a second term, but stories seem to suggest it was Marcus' decision. President Zuma will pick her successor. Rand weakness picked up a bit on the Marcus news. Markets hate uncertainty and it's not clear who the successor will be. A softer rand reflect market concerns that Zuma will pick a more dovish Governor.