Emerging Markets: What has Changed

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

1) Hungary’s central bank turned dovish

2) The Turkish central bank signalled that it may cut rates next week during an emergency meeting.

3) Pakistan's central bank surprised with a more aggressive cut than expected

4) Russian central bank surprised with a rate cut

5) S&P downgraded Russia one notch to BB+ with a negative outlook

6) Brazilian oil giant Petrobras failed to release its corruption-related writedown figures in its earnings statement

7) Finance Minister Levy said Brazil doesn’t want to keep BRL artificially strong

8) Belarus President Lukashenko said the country was considering debt restructuring, but then said there would be no default

Over the last week, Qatar (+3.1%), Czech Republic (+1.8%), and Poland (+1.5%) have outperformed in the EM equity space as measured by MSCI, while Russia (-10.9%), Brazil (-6.4%), and UAE (-5.8%) have underperformed. To put this in better context, MSCI EM fell -3.0% over the past week while MSCI DM fell -1.2%.

In the EM local currency bond space, Israel (10-year yield -18 bp), the Philippines (-15 bp), and Indonesia (-12 bp) have outperformed over the last week, while Ukraine (10-year yield +161 bp), Brazil (+28 bp), and Turkey (+13 bp) have underperformed. To put this in better context, the 10-year UST yield fell -12 bp over the past week.

In the EM FX space, ILS (+1.7% vs. USD), PHP (+0.1% vs. USD), and PLN (+0.1% vs. EUR) have outperformed over the last week, while RUB (-9.2% vs. USD), BRL (-3.6% vs. USD), and TRY (-3.2% vs. USD) have underperformed.

1) Hungary’s central bank turned dovish. Although the bank kept rates steady at 2.1%, the language was a noticeable shift. The statement referred to a “shift towards the alternative scenario implying looser monetary policy,” but also noted that current rates are adequate. Since the de-peg of the Swiss franc does not seem to be a big concern, we doubt that the risk of a weaker forint would hold back the bank from easing. EUR/HUF is well off its highs following the SNB move and is trading back in the wide range it has been in since the start of 2014. While we think more easing is on the table, it is not yet a given.

2) The Turkish central bank signalled that it may cut rates next week during an emergency meeting. Governor Basci plans on meeting after the inflation report comes out on February 3rd to decide. He also said that if the fall in inflation rate is bigger than one percentage point, then there could be easing. On a y/y basis, January CPI is expected to fall from 8.17% to 6.76%. Unsurprisingly, the dollar is making new all-time highs against the lira, which would argue for postponing any emergency rate cuts. Indeed, the bank tried some damage control, saying market moves were not in line with rate cuts. Too little, too late?

3) Pakistan's central bank surprised with a more aggressive cut than expected. The bank eased by 100 bp to 8.50%, when only a 50 bp cut was expected. This follows a 50 bp cut in November, which came with a downward revision to its economic forecast. Officials cited improving macroeconomic conditions, declining inflation, rising foreign exchange reserves, and a contained fiscal deficit as factors behind this latest cut.

4) Russia central bank surprised with a rate cut. The policy rate was lowered 2 percentage points to 15.0%. We knew that the new man at the central bank, Dmitry Tulin, was placed as the head of monetary policy to take some action, but we didn’t expect it to happen so soon. The central bank stated that “Inflation and inflation expectations are forecast to decrease as the economy gradually adjusts to changing external conditions and the impact of the exchange-rate dynamics on prices wanes.” We expect to revisit the December lows for the ruble in the coming weeks.

5) S&P downgraded Russia one notch to BB+ with a negative outlook. We totally agree with this move to junk, as our model has Russia at BB+/Ba1/BB+. But the situation remains fluid, and we could easily see more cuts ahead to BB or lower if the sanctions are widened and/or oil falls further. As it is, EU Foreign Ministers just extended the targeted sanctions for another six months.

6) Brazilian oil giant Petrobras failed to release its corruption-related writedown figures in its earnings statement. It seems as if directors couldn’t agree on a methodology to estimate the cost of the corruption scandals to the company. So while Petrobras met the deadline to release its Q3 earnings, it was hardly satisfying to investors. The stock price initially tumbled 12%. Petrobras also announced that it would cut 2015 investment to $31-33 bln compared with $42 bln budgeted for last year. This would be the lowest since $29.9 bln in 2008.

7) Finance Minister Levy said Brazil doesn’t want to keep BRL artificially strong. This is his first substantive comment on the exchange rate, and sounds like a signal that the central bank will start to pare back its FX swaps program. Between this and the awful fiscal data (primary deficit of -0.63% of GDP was the worst since November 1998, nominal deficit of -6.7% of GDP was the worst since August 1999), sentiment remains poor. Brazil has a few months to turn things around. Otherwise, we think a junk rating will be seen. We already saw it with Russia, so agencies are not shy about downgrading to junk if it’s warranted.

8) Belarus President Lukashenko said the country was considering debt restructuring, but then said there would be no default. Yields spiked for foreign currency government debt spiked over 100 bp, now trading around 25% today and this comes after a near 40% depreciation just this month. The country could tap Russia for up to $500 mn in aid, to help replay with the $4 bn in debt coming due this year.