Emerging Markets: What has Changed

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

1) OPEC members have started a price war even as their oil output climbed to the highest level in over a year

2) Recent inflation data out of India came as a much welcomed relief, and a fuel subsidy reduction is in sight

3) Bank of Korea cut rates again, negating their forward guidance of a “one and done” move back in August

4) The ruling party in Hungary, Fidesz, scored another resounding victory

5) The Russian central bank announced a $50 bln repo agreement running through 2016 to help support the ruble, even as continues to lose ground

6) The second round of the Brazilian presidential election is in a dead heat

Over the last week, Hong Kong (-0.5%), Korea (-0.6%), and Indonesia (-1.1%) have outperformed in the EM equity space as measured by MSCI, while Greece (-16.7%), UAE (-10.3%), and Brazil (-7.3%) have underperformed. To put this in better context, MSCI EM fell -3.8% over the past week while MSCI DM fell -4.3%.

In the EM local currency bond space, Chile (10-year yield -29 bp), Turkey (-26 bp), and Hong Kong (-16 bp) have outperformed over the last week, while Brazil (10-year yield +40 bp), Russia (+17 bp), and Hungary (+10 bp) have underperformed. To put this in better context, the 10-year UST yield was down -20 bp over the past week.

In the EM FX space, CLP (+0.3% vs. USD), KRW(+0.3%), and ILS (+0.2%) have outperformed over the last week, while BRL (-3.1% vs. USD), RUB (-2.2%), and COP (-1.5% vs. USD) have underperformed.

1) OPEC members have started a price war even as their oil output climbed to the highest level in over a year. Saudi Arabia continues to cut prices in Asia in an apparent effort to maintain its market share, rather than acting as the swing producer and cutting output to help support oil prices. Downward pressure on oil continues, as International Energy Agency reduced its forecast for global oil consumption this week. It cited stagnant economies in Europe as well as slow growth in China and other EM countries.

2) Recent inflation data out of India came as a much welcomed relief, and a fuel subsidy reduction is in sight. September CPI inflation fell to 6.5% y/y from 7.8% in August, and WPI inflation fell to 2.4% from 3.7%. Both numbers were lower than consensus expectations. Lower commodity prices surely played an important role in the decline, with food, fuel, and energy prices falling sharply. Rajan’s 8% inflation target for 2014 should be easy to achieve, but the 6% target for 2015 will depend largely on the government’s ability to deliver on fiscal consolidation and on how a possible reduction of fuel subsidies will play out. Indeed, central bank Governor Rajan has called on Modi to “seize this moment” of lower inflation and subdued fuel prices to make the changes to the fuel subsidy system.

3) Bank of Korea cut rates again, negating their forward guidance of a “one and done” move back in August. The bank also shifted its 2015 economic forecasts lower, with GDP growth seen at 3.9% vs. 4.0% previously and CPI inflation seen at 2.4% vs. 2.7% previously. The JPY/KRW cross moved back above the key 10 level this week for the first time since August. This will be helpful for the Korean economy, but think further easing by the BOK is likely.

4) The ruling party in Hungary, Fidesz, scored another resounding victory. Orban’s party made significant gains in the municipal elections last weekend. The party did well in the April general elections, as well as the elections for the European Parliament. This means that Orban has a strong mandate to impose its program. Recently, the focus now is on the government’s change of posture towards FX. Instead of welcoming a more competitive currency, it is now sending clear signals that they favour a stronger – or at least stable – forint. The reason is that given the amount of foreign debt, a weaker currency increases the country’s liabilities, with special attention given to the debt conversion plan to local currency as well as the potential breach of the EU’s excessive-deficit procedure, which could put aid it receives from Brussels at risk.

5) The Russian central bank announced a $50 bln repo agreement running through 2016 to help support the ruble, even as continues to lose ground. Sanctions, geopolitical tensions, and now collapsing oil prices have created the perfect storm for the currency. The central bank has shifted the trading band for the seventh consecutive day through Wednesday. Reports suggest that the central bank has spent around $6 bln of reserves just this month to contain the decline, and that interest rate hikes are being considered. Given ongoing stresses in EM, we expect RUB to continue underperforming regardless of the support measures.

6) The second round of the Brazilian presidential election is in a dead heat. The latest polls suggest a technical tie between the challenger Aecio Neves and incumbent Dilma Rousseff. According to the IBOPE polling institute, Aecio has 51% of voters’ intentions vs. 49% for Dilma. We should, however, take this with a grain of salt given the surprising outcome of first round of the race. Brazilian assets prices are directionless at the moment, caught between too many internal and external uncertainties, and the extremely high volatility seen across most financial markets.