Emerging Markets: What has Changed

(from my colleague, Dr. Win Thin)

1) The Brazilian congress passed a new measure that will hurt the fiscal outlook

2) Brazil central bank kept the inflation target for 2017 the same at 4.5%, but narrowed the tolerance band to +/ 1.5 percentage points

3) Israel central bank has gotten less dovish

4) Nigeria central bank banned importers from accessing the FX market for some goods

5) US Treasury Secretary Lew said that China committed to limit FX intervention only to times of “disorderly market conditions.”

6) China’s cabinet is moving to scrap a rule that limits lending by commercial banks to 75% of their deposits

In the EM equity space, Korea (+2.1), South Africa (+1.9), and India (+1.8%) have outperformed over the last week, while China (-6.5%), Indonesia (-1.2%), and Russia (-1.1%) have underperformed. To put this in better context, MSCI EM rose 0.6% over the past week while MSCI DM rose 0.5%.

In the EM local currency bond space, Ukraine (10-year yield -51 bp), Turkey (-36 bp), and Hungary (-26 bp) have outperformed over the last week, while Israel (10-year yield +30 bp), Singapore (+16 bp), and India (+10 bp) have underperformed. To put this in better context, the 10-year UST yield rose 19 bp over the past week.

In the EM FX space, TRY (+1.2% vs. USD), ILS (+0.8% vs. USD), and HUF (+0.3% vs. EUR) have outperformed over the last week, while RUB (-2.0% vs. USD), MXN (-1.4% vs. USD), and SGD (-1.0% vs. USD) have underperformed.

1) The Brazilian congress passed a new measure that will hurt the fiscal outlook. The lower house has approved an amendment that raises pension payments by the same formula used to calculation minimum wage increases. Social Security Minister Gabas said it would cost the government an extra BRL9.2 bln per annum. Levy is fighting a recession as well as a rebellious congress. With the fiscal deficit too high already, our sovereign rating model has moved Brazil into BB+ territory now after it barely hung on to BBB- last quarter. Downgrade risk is rising.

2) Brazil central bank kept the inflation target for 2017 the same at 4.5%, but narrowed the tolerance band to +/ 1.5 percentage points from +/-2 percentage points currently. We don't really want to read too much into it, but the central bank is trying to add to its hawkish credentials. Right now, markets are pricing in a 50 bp hike in July and another 25 bp hike in September. Markets are also starting to price in a potential 25 bp hike in October. If true, this would take the SELIC rate up to 14.75% from 13.75% currently. Yet the real remains under pressure, and rightfully so since the fundamental and political backdrop remains awful.

3) Israel central bank has gotten less dovish. It left rates steady this week at 0.10%, as expected. However, Governor Flug’s comments afterwards suggest there is a high bar for another rate cut or unorthodox measures. She noted that the chances for using unconventional measures has decreased, and added that inflation expectations are returning towards target. We see steady policy for now, but with a bias to weaken the shekel. The central bank intervened this week as the shekel firmed after the central bank meeting.

4) Nigeria central bank banned importers from accessing the FX market for some goods. Forty categories of goods were listed. The bank also halted access to the interbank FX markets for buying Eurobonds and foreign equities. The move is meant help preserve foreign reserves, which have fallen below $30 bln for the first time since 2005, due to low oil prices.

5) US Treasury Secretary Lew said that China committed to limit FX intervention only to times of “disorderly market conditions.” At the same time, China Vice Premier Wang Yang said that the US pledged to respect IMF procedures on China’s efforts to be included in the SDR. The comments emerged after the annual Strategic & Economic Dialogue, the seventh round so far. While China has been promising to adopt a more flexible exchange rate regime for years, this may be the first time that a specific intervention strategy was publically addressed.

6) China’s cabinet is moving to scrap a rule that limits lending by commercial banks to 75% of their deposits. Clearly, this is meant to free up more money to lend as policymakers struggle to support growth. The State Council will propose amending the banking laws to turn the 75% into a reference rate rather than a regulatory requirement. Changes to the law need to be approved by the Standing Committee of the National People’s Congress.

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