Emerging Markets: What has Changed

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

1) Petrobras’ credit rating was cut to junk by Moody’s
2) PBOC fixed USD/CNY at 6.1475 Friday, the highest level since November
3) Israel’s central bank surprised markets with another cut to its benchmark rate to 0.10%
4) Turkey’s central bank tweaked its FX intervention program
5) Hungarian voters deliver a significant defeat to the ruling party
6) Russia was cut to junk (Ba1) by Moody's late last Friday
7) Ukraine stepped up some capital controls as the hryvnia continues to plunge
8) Argentina’s president Cristina Fernandez got a pass from state prosecutors
Over the last week, Hungary (+2.1%), Mexico (+1.9%), and Malaysia (+1.9%) have outperformed in the EM equity space as measured by MSCI, while Russia (-2.1%), Colombia (-1.9%), and Turkey (-1.2%) have underperformed.  To put this in better context, MSCI EM rose 0.5% over the past week while MSCI DM rose 0.4%.

In the EM local currency bond space, Brazil (10-year yield -50 bp), Hungary (-35 bp), and Israel (-24 bp) have outperformed over the last week, while Russia (10-year yield +52 bp), Turkey (+50 bp), and Ukraine (+11 bp) 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, KRW (+1.3% vs. USD), MYR (+1.2%), and TWD (+0.9%) have outperformed over the last week, while ILS (-3.4% vs. USD), TRY (-2.5%), and COP (-1.6%) have underperformed.

1) Petrobras’ credit rating was cut to junk by Moody’s. The move was expected given the dire situation the company is in, but it may have been more aggressive than many had thought. The agency cut the company to Ba2, two levels below investment grade, and kept a negative outlook. The other two major rating agencies still have Petrobras as investment grade, but only just. It’s a matter of time until they follow suit. Bonds are already trading in high-yield territory, with the 2024 bond at 7.7% yield. The same bond made a low at 4.74% in September last year.

2) PBOC fixed USD/CNY at 6.1475 Friday, the highest level since November.  With spot USD/CNY trading right at the 2% band limit, it is now at its highest level since October 2012.  Still, we note that this fix is only slightly above the middle of range for the last 12 months (roughly 6.11-6.17), and is also pretty much right at the average fix over this time period of 6.1460.  For now, we remain skeptical that the weakness in the yuan will be a sustained trend.  US Treasury Undersecretary for International Affairs Sheets recently noted that China has stopped intervening in the FX market, suggesting US criticism of China’s FX policy is easing.  Let’s see if there is any US response if USD/CNY continues to rise.

3) Israel’s central bank surprised markets with another cut to its benchmark rate to 0.10%. Everyone (including us) was looking for no change. We were looking for the bank to talk down the shekel, but it looks like policymakers wanted to send a stronger message.  ILS has been one of the top EM performers YTD.  The move also underscores the fact that asymmetric risks remain in EM monetary policy. 

4) Turkey’s central bank tweaked its FX intervention program.  In the past, daily amounts were set.  Now, they are variable on a daily basis.  From the central bank website:  "The amount of foreign exchange selling auctions will be set on a daily basis depending on the conditions in the foreign exchange market starting from 27 February 2015."  Obviously, TRY weakness is becoming an issue.  However, if policymakers really want to prevent excess FX volatility, then government officials should stop attacking the central bank.  No matter how they handle their FX intervention program, the political and economic backdrop remains TRY-negative.

5) Hungarian voters deliver a significant defeat to the ruling party. Prime Minister Orban’s Fidesz party lost a parliamentary by-election and thus also lost the 2/3 super-majority in parliament they held for the last five years.  The result seemed to be reflecting more of an ideological protest than a worsening of Hungary’s economic reality.  Some issues that dented Orban’s popularity were the attempted internet tax, greater proximity to Russia and alleged government corruption. We can’t see any major changes to the outlook for Hungary, as we doubt the loss will result in a more market-friendly approach by Fidesz.

6) Russia was cut to junk (Ba1) by Moody's late last Friday. This was not a big surprise, as this follows S&P's downgrade to BB+ back in January.  Our model has it at BB+/Ba1/BB+ but the fundamentals are still deteriorating and further cuts are very possible.  Now that 2 out of 3 agencies have Russia at junk, there may be some forced selling of Russian bonds.  Meanwhile, the US said it would consider blocking more Russian banks from the global financial system if the Ukraine ceasefire continues to be violated by Russian-backed rebels.

7) Ukraine stepped up some capital controls as the hryvnia continues to plunge.  The National Bank of Ukraine will curb importer purchases of FX, and has also banned banks from lending to clients seeking to sell the hryvnia.  Governor Valeriya Gontareva said more tools are available if needed to limit outflows.  Meanwhile, Ukraine faces a potential gas shortage due to the ongoing payments dispute with Russia’s Gazprom.  With the central bank running dangerously low on foreign reserves, payments for gas deliveries are being made on a virtual day-to-day basis.

8) Argentina’s president Cristina Fernandez got a pass from state prosecutors, who dismissed charges against her.  She was accused of conspiring to cover up Iran’s alleged involvement in a 1994 synagogue bombing that killed 85 people.  The case was originally brought by prosecutor Nisman, who was found dead last month, but this judge dismissed the allegations.  Needless to say, tensions will continue to escalate and polarize the Argentinian society ahead of the presidential elections in 2015.