Emerging Markets: What has Changed

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

1) Brazil’s government cut the primary surplus target for 2015 to 0.15% of GDP 

2) The situation in Turkey is becoming even more complicated, reinforcing our view that the tail risks are increasing

3) It appears as if Ukraine has made its debt payment today, avoiding default

4) Press is reporting that the Mexican FX commission is mulling additional measures to help support the peso

5) The United Arab Emirates will link domestic gasoline and diesel fuel prices to global oil prices starting next month

6) The SARB hiked rates 25 bp to 6%, as many expected

7) The Czech central bank intervened in the FX market for the first time since 2013

8) Indonesia’s Financial Services Authority has taken some macroprudential measures to help boost bank lending.

In the EM equity space, UAE (+2.2), Philippines (+0.6%), and China (+0.6%) have outperformed over the last week, while Brazil (-5.6%), Turkey (-4.4%), and Poland (-4.2%) have underperformed. To put this in better context, MSCI EM fell -3.3% over the past week while MSCI DM fell -1.3%.

In the EM local currency bond space, Czech Republic (10-year yield -21 bp), Korea (-13 bp), and Hungary (-11 bp) have outperformed over the last week, while Brazil (10-year yield +58 bp), Turkey (+45 bp), and Russia (+32 bp) have underperformed.  To put this in better context, the 10-year UST yield fell -9 bp over the past week. 

In the EM FX space, CZK (+0.1% vs. EUR), EGP (+0.1% vs. USD), and CNY (flat vs. USD) have outperformed over the last week, while BRL (-4.1% vs. USD), TRY (-3.4% vs. USD), and COP (-3.1% vs. USD) have underperformed.

1) Brazil’s government cut the primary surplus target for 2015 to 0.15% of GDP.  Much of the budgetary shortfall can be traced to the economy, which is contracting more than expected even as interest rates head higher.  Either way, it will increase speculation of a credit downgrade (we think it will happen).  And at the same time, the carry buffer is shrinking as markets began changing their forecast to one more 25 bp hike to end the cycle, instead of 50 bp.  We are less convinced.  Either way, the combination of factors is weighing heavily on Brazilian assets. 

2) The situation in Turkey is becoming even more complicated, reinforcing our view that the tail risks are increasing.  This is highlighted by two major developments.  First, the series of deadly terrorist attacks this week tips the current administration to take stronger action in the foreign policy space.  This already started to happen, with Turkey granting the US use of its military bases to launch attacks against ISIS/ISIL.  Second, recent comments about a possible coalition government between the AKP and the main opposition party (CHP) may have given investors a false sense of optimism about avoiding early elections.  We doubt an agreement will be reached with the CHP.  If anything, we still believe that the Kurdish HDP has the most to gain from a coalition with the AKP.  But fresh elections are very possible.

3) Ukraine has made its debt payment today, avoiding default.  In order to secure IMF funding, Ukraine must reduce its debt levels.  Ukraine has proposed a 40% haircut to its private creditors, who obviously didn’t like the idea.  Instead, the private creditors want Ukraine to use its reserves to service the debt.  The IMF and the US have sided with Ukraine, preparing to loan them money even if it defaults.  The IMF will meet on July 31 to discuss its next step.

4) Press is reporting that the Mexican FX commission is mulling additional measures to help support the peso.  Potential measures would be to offer more USD in extraordinary auctions or to decrease the daily depreciation threshold (now -1.5%) that triggers the automatic circuit-breaker $200 mln USD auctions.  There have been no official comments, but it wouldn't be surprising.  But remember, they would only be doing this to help avoid big, gappy MXN moves.  Mexican officials are very hands off with regards to levels, but may be growing more concerned about the second round effects of a weaker peso.

5) The United Arab Emirates will link domestic gasoline and diesel fuel prices to global oil prices starting next month, becoming the first country in the Persian Gulf to remove fuel subsidies.  Fuel prices will be deregulated as of August 1, according to the Ministry of Energy, and prices for both fuels will be announced on the 28th day of each month.  Gasoline is now subsidized in the UAE, as unleaded 98 octane gasoline sells for 1.83 dirhams (50 cents) per liter.  This compares to a US price of $3.18 per gallon (84 cents per liter), according to the AAA, as well as to 16 cents per liter in Saudi Arabia.

6) The SARB hiked rates 25 bp to 6%, as many expected.  This was the first move in a year, with the last 25 bp coming on July 17 2014.  We think the move was a bit precocious, especially with commodity prices heading lower again.  Either way, we doubt the move will do much for the rand, which should continue weakening.  As it is, the rand ended weaker on the day despite the hike.  Any firmness should be viewed as an opportunity to sell it at better levels.  

7) The Czech central bank intervened in the FX market for the first time since 2013.  Optimism on the economy has seen EUR/CZK slip close to the floor “around” 27.  The Czech National Bank confirmed the activity, but declined to comment on the volumes and levels.  The central bank is ready to “automatically intervene for an unlimited time and in unlimited volumes to keep the koruna rate close to the level of 27 per euro.  The CNB only acts against exchange-rate appreciation beyond the declared level.”  The bank has pledged to maintain the floor until “at least” H2 2016.

8) Indonesia’s Financial Services Authority has taken some macroprudential measures to help boost bank lending.  The FSA will relax risk-weighted asset rules for consumer bank lending, and will also loosen NPL rules for finance companies.  Both are meant to free up bank capital for more lending.  Policymakers are struggling to boost growth even as interest rates remain stuck at 7.5% due to high inflation.  FSA also lowered its loan growth forecast for this year to 13-15%, down from 16-17% previously.

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