Emerging Markets: What has Changed This Week

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

1) Oil prices have taken another sharp leg down 

2) The People’s Bank of China surprised the markets with rate cuts last Friday 

3) Malaysia cut fuel subsidies just days after Indonesia’s new President Joko Widodo took similar measures 

4) Nigeria devalued the naira, moving the peg rate and widening the band around that rate to +/- 5 percentage points from +/- 3 previously 

5) Joaquim Levy will be the new Finance Minister for Brazil

Over the last week, China (+3.7%), Czech Republic (+3.4%), and Korea (+3.0%) have outperformed in the EM equity space as measured by MSCI, while Russia (-7.1%), Colombia (-5.3%), and Qatar (-3.1%) have underperformed.  To put this in better context, MSCI EM rose 0.4% over the past week while MSCI DM rose 0.3%.

In the EM local currency bond space, Turkey (10-year yield -41 bp), Brazil (-21 bp), and the Philippines (-15 bp) have outperformed over the last week, while Ukraine (10-year yield +97 bp), Russia (+34 bp), and Colombia (flat) have underperformed.  To put this in better context, the 10-year UST yield fell -10 bp over the past week.

In the EM FX space, TRY (+0.6% vs. USD), KRW (+0.5% vs. USD), and PLN (+0.4% vs. EUR) have outperformed over the last week, while RUB (-6.9% vs. USD), COP (-2.3% vs. USD), and CLP (-1.7% vs. USD) have underperformed.

1) Oil prices have taken another sharp leg down.  OPEC, which over-produced in October, decided to roll over the existing quota 30 mln barrels a day.  We note that the timing of its next meeting is an important signal.  It did not decide to schedule a meeting in the February-March period, when the seasonal demand slackens.  Instead, the next OPEC meeting is for June.  The market's reaction was immediate.  The price of Brent oil has fallen over $5 and slipped below $73 a barrel.  The price of the US benchmark West Texas Intermediate Crude oil has also fallen about $5 and slipped to around $69 a barrel.  The IMF estimates that every $10 drop in the price of oil boosts world's growth by 0.2%.  The drop in oil prices can be expected to boost growth by around 0.8% or so in 2015.  The near-term outlook for EM is mixed.  Oil-producing countries (largely in Latin America, the Middle East, and Africa) will lose, while oil-consuming countries (largely in Asia and Eastern Europe) will win.  Russia is the outlier in that region, and stands to lose greatly from lower oil prices.

2) The People’s Bank of China surprised the markets with rate cuts last Friday.  The 1-year lending rate was cut 40 bp to 5.6%, while the 1-year deposit rate was cut 25 bp to 2.75%.  It was also a big week in China for initial public offerings.  The CNY1.6 trillion worth of shares brought to market was reportedly the most of the year.  The anticipation has tied up liquidity and had lifted money market and repo rates in recent days.  Finally, we note that HK-Shanghai equity link did not produce the big bang that many anticipated.  It suggests that the missing element, at least at the moment, is desire rather than access.  

3) Malaysia cut fuel subsidies just days after Indonesia’s new President Joko Widodo took similar measures.  In light of the recent slump in oil prices, Prime Minister Najib Razak announced the total elimination of fuel subsidies last Friday.  Starting December 1, the price of the gasoline and diesel fuel will be set by a managed float.  Moody’s gave the move a thumbs up, stating “Significant consolidation of the government’s fiscal deficits and the debt burden could trigger an upgrade."  Eliminating fuel subsidies will clearly help the budget outlook.

4) Nigeria devalued the naira, moving the peg rate and widening the band around that rate to +/- 5 percentage points from +/- 3 previously.   The central bank also hiked its policy rate 100 bp to 13%.  The new trading band for NGN is approximately 159.60-176.40 around the new peg rate of 168.  The old band was approximately 150.35-159.65 around the old peg rate of 155. The central bank reportedly sold dollars earlier in the week at 162.50, which was outside of the old band.  As such, the devaluation really shouldn't come as too much of a surprise. Inflation at 8.1% y/y in October remains near the cycle lows, and so the rate hike should be seen as a precautionary measure.  Obviously, Nigeria fell victim to lower oil prices, and we think Venezuela is the next obvious target given its bolivar peg and reliance on oil exports.  

5) Joaquim Levy will be the new Finance Minister for Brazil.  At his appointment Thursday, Levy announced a primary surplus target of 1.2% of GDP in 2015, followed by 2% in both 2016 and 2017.  This is hardly an aggressive tightening, but even then, the targets will be hard to meet given the absence of growth.  Expectations for full year growth are around 0.3%.  For 2015 and 2016, consensus is for 1% and 2% growth, respectively.  Barbosa will become the new Planning Minister.  In any case, the government will be in a tight spot between the weak economy, as well as the impact of the corruption scandal relating to Petrobras and the country’s large construction companies.  For USD/BRL, one of the key questions is what will happen with the FX swaps program?  There are no signs that they are looking to unwind it yet, but if they do, it will pressure the pair higher.