Emerging Markets: What Has Changed

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

1) USD/HKD traded at its highest level since May 2012.

2) Russian officials confirm that capital controls are not on the cards.

3) The Turkish central bank started to push bank against currency weakness – albeit slightly.

4) Dilma’s chances of re-elections increased further.

5) Argentine central bank Governor Fabrega resigned.

6) Uruguay has cut the reserve requirement on government bonds to zero, and on central bank bond purchases to 30%.

Over the last week, the Czech Republic (+1.0%), India (+0.7%), and South Africa (+0.6%) have outperformed in the EM equity space as measured by MSCI, while Brazil (-7.5%), Russia (-6.6%), and Korea (-4.1%) have underperformed. To put this in better context, MSCI EM fell -3.2% over the past week while MSCI DM fell -1.8%.

In the EM local currency bond space, Thailand (10-year yield -15 bp), Korea (-13 bp), and Singapore (-10 bp) have outperformed over the last week, while Brazil (10-year yield +45 bp), Indonesia (+30 bp), and Colombia (+18 bp) have underperformed. To put this in better context, the 10-year UST yield was down -9 bp over the past week.

In the EM FX space, HUF (+0.6% vs. EUR), CLP (+0.6% vs. USD), and ILS (+0.4% vs. USD) have outperformed over the last week, while RUB (-2.9% vs. USD), KRW (-1.8% vs. USD), and BRL (-1.8% vs. USD) have underperformed.

1) USD/HKD traded at its highest level since May 2012. Last weekend’s demonstrations are clearly a catalyst for this week's big move, but HKD was already moving off the strong end of the band before the weekend, which reflected the building negative EM sentiment. The HKMA's intervention band is 7.75-7.85, centered around 7.80. We are nowhere close to where HKMA would need to intervene to support HKD. That said, we do not think anyone doubts the HKMA’s ability to maintain the peg. The Hong Kong protests continue but we have not yet seen any acceleration of tensions.

2) Russian officials confirm that capital controls are not on the cards. After much speculation, this option seems to be ruled out – for now. Still, the government is unlikely to tolerate this pace of ruble weakness for long and will increase its efforts via FX intervention. Some estimates suggest that capital outflows will soon reach $100 bln, the highest since 2008.

3) The Turkish central bank started to push bank against currency weakness – albeit slightly. The bank raised the daily amount of USD sales to $40 mln from $10 mln, citing the increase in currency volatility. The lira is down 4.2% against the dollar this month. Yesterday, the bank left all rates unchanged, as expected. This was the right thing to do, and we suspect even Erdogan knows that cutting rates while USD/TRY is making new highs would be a dangerous gamble. Note that 2.2650 is a key retracement level and a clean break would target the January high near 2.39. Given how EM has been trading, this seems to be a likely scenario for Q4.

4) Dilma’s chances of re-elections increased further. Recent polls show that the incumbent, Dilma Rousseff, has further increased her advantage over the second place opposition candidate, Marina Silva. Moreover, the third place in the race, Aecio Neves, has closed in to Marina and now has a shot at making it to the second round. All in all it still remains an unpredictable race since many factors will change in the second round. First, the two candidates will have equal TV advertisement time. And second, a possible alliance between the opposition parties could be impactful.

5) Argentine central bank Governor Fabrega resigned. Fabrega quit after President Fernandez accused the bank of leaking inside information about FX policy, but we suspect that the row is really being driven by a clash on policy itself. We would expect a further move away from orthodoxy with regards to central bank policy. For now, negative developments in Argentina are unlikely to impact wider EM.

6) Uruguay has cut the reserve requirement on government bonds to zero, and on central bank bond purchases to 30%. The reserve requirements apply to local bonds held by non-residents, so this looks to be a proactive move to keep foreign capital flows coming in and/or limiting disruptive outflows. Is Uruguay a canary in a coal mine? This is a very important development, as capital flight is an issue that will be faced by most EM countries in the coming months as Fed tightening gets nearer and nearer.