Emerging Markets: What has Changed

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

1) The won-yen story is back after Vice Finance Minister Hwan stated that authorities will manage won moves in line with the yen
2) Poland unexpectedly paused its easing cycle; separately, Poland wants to reduce the size of its Monetary Policy Council from 10 to 7
3) The Russian central bank changed its intervention regime after it became clear that the rate hike was ineffectual
4) Politics are heating up again in Ukraine
5) Brazil released the minutes from last week’s meeting


Over the last week, Egypt (+5.1%), India (+2.1%), and Peru (+1.3%) have outperformed in the EM equity space as measured by MSCI, while Russia (-7.3%), Brazil (-4.9%), and Korea (-4.0%) have underperformed.  To put this in better context, MSCI EM fell -1.6% over the past week while MSCI DM rose 0.8%.

In the EM local currency bond space, Hungary (10-year yield -14 bp), China (-11 bp), and Indonesia (-10 bp) have outperformed over the last week, while Brazil (10-year yield +36 bp), Russia (+21 bp), and South Africa (+8 bp) have underperformed.  To put this in better context, the 10-year UST yield rose +6 bp over the past week.

In the EM FX space, PKR (+0.5% vs. USD), INR (+0.1%), and CNY (flat) have outperformed over the last week, while RUB (-10.6% vs. USD), BRL (-5.7%), and KRW (-2.7%) have underperformed.

1) The won-yen story is back after Vice Finance Minister Hwan stated that authorities will manage won moves in line with the yen.  This is neither new nor unexpected, and we place only moderate weight on this ramp up in rhetoric.  First, there will be a lag between verbal and actual intervention.  Second, even if the BOK starts to take action, it’s unlikely that the won will keep up or match the yen depreciation so far.  Third, the yen has much stronger fundamental reasons to weaken than the won (for example, Korea runs a current account surplus of nearly 6% of GDP, compared with a 1% surplus for Japan).  So, this is a factor to watch, but probably more in terms of the won’s performance against other Asian currencies.  It does add some uncertainty ahead of the BOK meeting next week (November 13).

2) Poland unexpectedly paused its easing cycle.  Markets were almost unanimously looking for a 25 bp cut, with some calling for a 50 bp cut. The bank left the door open for further cuts, as its focus has shifted to growth.  Even though CPI is hovering close to zero, it seems the bank sees no real risk of prolonged deflation. Separately, Poland wants to reduce the size of its Monetary Policy Council from 10 to 7.  Under legislation being prepared by the Finance Ministry, the 7-member council would not be put into effect until 2022.  Membership will be rotated so that half of the council will be replaced every three years.  This is a sensitive matter after the scandal earlier this year that showed the central bank seeming to favor the current government.

3) The Russian central bank changed its intervention regime after it became clear that the rate hike was ineffectual.  Now, the bank will only spend $350 mln once per day when it falls outside of the trading band.  However, it has leeway to then conduct more interventions at its own discretion regarding amounts and timing.  It delivered a larger than expected 150 bp hike last Friday, but it did nothing to help the ruble.  So where does this leave us?  Time will tell.  This is clearly a regime change, but it’s not clear yet if, in practice, it means we are closer to a free floating regime. It does, however, look like capitulation and admission that they have tried and failed to stem (or even slow down) the move in the currency.  At least the new system will help the bank to save face if the move continues – i.e. blaming it on “market factors.”

4) Politics are heating up again in Ukraine. A pro-Russian separatists group held their own weekend elections in the eastern territories of Donetsk and Luhansk.  Ukrainian President Poroshenko has called for the disputed votes to be annulled.  NATO warned that Russian troops were moving closer to the border, and said Russia continues to provided “equipment and support” for the separatists.  Meanwhile, the Ukraine army is sending reinforcements and heavy armor to the border areas to defend against any future moves by Russian troops.  As of this writing, there are new press reports of Ukraine beginning a new large-scale offensive in the east.

5) Brazil released the minutes from last week’s meeting.  The bank had surprised markets with a 25 bp hike then.  It cited a less favorable balance of risks to inflation due to the weaker real and increases in regulated prices, with projected inflation getting worse in all the scenarios analyzed by the bank.  Further hikes seem likely, but it will be hard to undo the impression that either the hike or the delay in hiking happened for political reasons.  October IPCA inflation will be reported Friday, expected to rise 6.65% y/y vs. 6.75% in September.  After the minutes, this IPCA print should give markets a better idea of how much tightening to expect ahead.