Emerging Markets: What has Changed

(from my colleague Dr. Win Thin)

Tensions between India and Pakistan are rising.
The Philippine government ordered the suspension of three quarters of the nation’s mines.
Czech central bank sounds more confident of the cap exit.
Poland’s Finance Minister Szalamacha was sacked.
Moody's downgraded Turkey one notch to Ba1 with a stable outlook.
The Brazilian central bank's quarterly inflation report set the table for the easing cycle to start.

In the EM equity space as measured by MSCI, Colombia (+2.1%), Mexico (+1.0%), and Singapore (+0.5%) have outperformed this week, while Turkey (-4.2%), China (-2.5%), and Poland (-2.2%) have underperformed.  To put this in better context, MSCI EM fell -1.5% this week while MSCI DM fell -0.6%.

In the EM local currency bond space, Brazil (10-year yield -12 bp), Mexico (-12 bp), and Russia (-9 bp) have outperformed this week, while Turkey (10-year yield +20 bp), Indonesia (+19 bp), and Ukraine (+19 bp) have underperformed.  To put this in better context, the 10-year UST yield fell 6 bp this week to 1.56%. 

In the EM FX space, MXN (+1.8% vs. USD), RUB (+1.4% vs. USD), and COP (+1.4% vs. USD) have outperformed this week, while PEN (-1.4% vs. USD), HUF (-1.2% vs. EUR), and TRY (-1.2% vs. USD) have underperformed. 

Tensions between India and Pakistan are rising.  There were reports that India’s armed forces attacked terrorist camps in the Pakistani portion of Kashmir.  This is the biggest military operation involving the two countries since 1999, as Prime Minister Modi responds to a deadly attack on Indian soldiers earlier this month.  Tensions are likely to remain high near-term, but we hope that diplomacy eventually wins out.  

The Philippine government ordered the suspension of three quarters of the nation’s mines due to environmental violations.  The nation is the largest producer of nickel, accounting for around 25% of global output.  Environmental Secretary Lopez suspended operations at 30 mines that mainly produce nickel, which together account for over half of the nation’s nickel output.  Only 11 mines passed.  Coming on top of incendiary comments by President Duterte, foreign investors are likely to remain nervous.

Czech central bank sounds more confident of the cap exit.  It kept forward guidance at mid-2017, but Governor Rusnok noted that there is a “stronger” certainty of exit.  He added that he sees “minimal” risk of further delay in the koruna cap exit.  We don’t think this can be termed hawkish, but it's certainly less dovish.  That said, a lot can happen between now and mid-2017.  Signs of slowing in Germany suggest headwinds ahead that need to be monitored since it is Czech Republic's largest export destination.

Poland’s Finance Minister Szalamacha was sacked.  The post will be taken over by Deputy Prime Minister Morawiecki.  This move was part of a wider cabinet shuffle, which started last week with the sacking of the Treasury Minister.  Prime Minister Szydlo said that Szalamacha’s proposed 2017 budget would still be followed.

Moody's downgraded Turkey one notch to Ba1 with a stable outlook.  We agree with the move to sub-investment grade, but disagree with the stable outlook.  S&P cut Turkey to BB this summer.  Many investment mandates require at least two investment grade ratings in order to be investable, so Turkey could see some forced selling.  Fitch is now the sole agency with an investment grade rating on Turkey, but it too should follow suit and downgrade. 

The Brazilian central bank's quarterly inflation report set the table for the easing cycle to start.  The bank sees inflation hitting the official target of 4.5% next year.  If so, it would be the first time since 2009.  It noted that conditions for easing monetary policy are improving.  Note that the Brazilian CDI market is fully pricing in a 25 bp cut then, with some chance of a 50 bp cut.

Disclaimer