Emerging Markets: What has Changed

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

1) The Mexican central bank has taken rate cuts off the table (for now)

2) Venezuela’s modification of the FX regime seems like more of the same

3) Brazilian President Dilma’s popularity fell off a cliff

4) The Indian political landscape his shifted

5) A ceasefire was reached in Ukraine, though questions about implementation and duration will remain

6) Nigeria has delayed the presidential election until March 28.

7) S&P announced several ratings downgrades on oil producers

Over the last week, Russia (+10.3%), Hungary (+6.1%), and Czech Republic (+2.3%) have outperformed in the EM equity space as measured by MSCI, while Turkey (-3.5%), Korea (-3.1%), and Colombia (-3.0%) have underperformed. To put this in better context, MSCI EM rose 0.6% over the past week while MSCI DM rose 1.6%.

In the EM local currency bond space, Ukraine (10-year yield -79 bp), Russia (-55 bp), and China (-3 bp) have outperformed over the last week, while Indonesia (10-year yield +34 bp), Singapore (+18 bp), and Thailand (+15 bp) have underperformed. To put this in better context, the 10-year UST yield rose 5 bp over the past week.

In the EM FX space, RUB (+5.2% vs. USD), CLP (+1.2%), and COP (+0.6%) have outperformed over the last week, while ZAR (-1.8% vs. USD), BRL (-1.7%), and IDR (-1.4%) have underperformed.

1) The Mexican central bank has taken rate cuts off the table (for now). The bank has even started to discuss when to hike rates, with one board member arguing that this should happen before the Fed hikes. The weaker peso seems to be one of the key variables in their reaction function, and we believe it will help determine the timing. If MXN continues to weaken at this pace, it is possible that Banxico will hike before or around the same time the Fed does (June, in our view). However, much will depend on the economic trajectories that develop in H1.

2) Venezuela’s modification of the FX regime seems like more of the same. According to the plan, 70% of the “economy’s needs” will be met at the official rate of VEF 6.3, with the rest offered at a variable rate starting at VEB 12.0. Then a third channel, Simadi, allows for some freely floating exchange rate. But with the black market rate trading upwards of 160, this new regime is unlikely to change the underlying shortage of dollars that has left shop shelves bare. This week, S&P downgraded the nation one notch to CCC with a negative outlook.

3) Brazilian President Dilma’s popularity fell off a cliff. The latest polls showed that those who rate her government positively fell from 42% to 23% – the worst ratings for a president since 1998, when President Cardoso devalued the currency. Moreover, 77% of the people interviewed believe that she knew about the corruption at Petrobras. Meanwhile, in congress, the lower house approved a constitutional amendment that, if approved by the Senate, forces the government to execute certain expenditures. While the amount of new money allocated to these expenditures is debatable, it underscores the challenges the new Finance Minister will face to deliver its surplus targets.

4) The Indian political landscape his shifted. The ruling BJP lost badly in the Delhi local elections, calling into question just how far Prime Minister Modi can push his reform agenda nationally. The AAP’s landslide victory (winning 67 of 70 seats in the national capital of Delhi) signals that Modi’s nine-month old government may have trouble implementing reforms that markets have largely priced in. Later this month, Modi will submit his first full-year budget to parliament, and will be an important signal of the government’s intentions in light of the Delhi election.

5) A ceasefire was reached in Ukraine, though questions about implementation and duration will remain. We see this as a necessary, but insufficient step to avoid further escalation. Meanwhile, the IMF announced it was leading a new aid package totalling $40 bln. The news is unquestionably positive for the region and markets in general, but the situation remains fluid and prone to reversals. Ukraine CDS prices came sharply lower, falling from over 2500 bp to about 1900 bp. The news also took some pressure off Russian assets, which had already performing better with the rise in crude prices.

6) Nigeria has delayed the presidential election until March 28. The poll was original set for February, 14, but the government announced the delay as necessary due to security concerns. USD/NGN is making new all-time highs on the heightened political uncertainty, leading the central bank to intervene in support. S&P this week placed its BB- rating on Nigeria on CreditWatch Negative. This is a bit worse than just a negative outlook, as it typically implies a more imminent risk of downgrade. From S&P: "The CreditWatch placement indicates at least a one-in-two chance that we could lower our long-term ratings on Nigeria following our review of the government's policy response to a lower oil price environment."

7) S&P announced several ratings downgrades on oil producers. We agree with some of the cuts, but not with others. 1) The outlook on Saudi Arabia's AA- rating was cut from stable to negative. Our model has it at AA, so we disagree. Saudi Arabia has built up such huge financial buffers that it can ride out low oil prices for a long time; 2) Kazakhstan was cut from BBB+ to BBB with negative outlook. Our model has it at BBB-, so we agree; 3) Bahrain was cut from BBB to BBB- with negative outlook. Our model has it at BB+, so we agree; 4) Oman was cut from A to A- with stable outlook. Our model has it at AA, so we disagree. Bottom line: Low oil prices will take a toll on the producing countries, but some are better positioned than others. Nigeria and Venezuela in particular look to be very vulnerable going forward.