Category Archives: Emerging Markets

Be careful what you wish for

The rise in bond yields in developed economies in the past 6 weeks remains one of the over-riding themes as we head into the last seven days of the US presidential campaigns.

Markets are now fretting about the implications for global growth and asset valuations and ultimately whether elevated global risk appetite will correct more forcefully.

Higher international commodity prices, a pick-up in global GDP growth in Q3 and early Q4 and easing deflation fears suggest that interest rate policies in developed economies may have reached an important inflexion point – in line with the view I expressed six weeks ago.

Developed central banks may refrain from loosening monetary policy further near-term, with the exception of the RBNZ and possibly ECB. At the very least, policy-makers will tweak a discourse which has largely focused on doing “whatever it takes”.

Recent US data have paved the paved the way for a 14th December Fed hike, conditional on Democrat candidate Hilary Clinton wining the 8th November US presidential elections.

But with the exception of the Fed and possibly a handful of EM central banks, rate hikes are a story for the latter part of 2017 (perhaps) while further rate cuts remain on the cards in Brazil, Russia, Indonesia and India.

Higher global yields and still uncertain US election outcome are taming global equities and volatility has spiked but EM currencies have still managed to eek out modest gains.

Assuming Hilary Clinton wins next week, I would expect the initial reaction to be a rally in global equities, EM currencies and Dollar and an underperformance of safe-haven assets.

But I would also expect market pricing for a December Fed hike to rise a little further, which could in turn eventually curtail any rally in global equities and EM currencies.

In this scenario, the Dollar would likely end the year stronger, as per my January forecast of a third consecutive year of albeit more modest Dollar gains.

Whether global risk appetite avoids its early 2016 fate will depend on the interconnected factors of underlying macro data and the Fed’s credibility. In any case, market volatility could spike in the run-up to March 2017.

The self-reinforcing sell-off in Sterling and UK bonds has only very recently abated, with markets seemingly taken some comfort from a number of factors including the only modest slowdown in UK GDP growth to 0.5% qoq in Q3.

But optimism over UK GDP data is not warranted as growth has become more unbalanced and slowed in August-September despite a significant easing in UK monetary policy. Read more

Emerging markets – What will sour sweet spot?

Emerging market (EM) asset prices have performed well since the UK referendum on 23rd June. The overall driver is the perceived view that the risk-reward of investing in EM has improved, both due to better relative returns and more limited risks.

Major developed central banks’ willingness to keep monetary policy loose to put a floor under economic growth is central to this improved risk-reward trade-off for EM assets.

Near-zero rates in most developed markets have put in high-relief high-carry currencies such as the BRL and ZAR which are also benefiting from high global metals prices.

On the risk side of the equation, slowing rather than collapsing global growth and higher commodity prices have attenuated concerns about EM economies’ ability to prosper.

Moreover, stable and still significant EM central bank FX reserves have dulled fears about their ability to defend their currencies in the event of an endogenous or external shock.

At the same time, acute economic, political and geo-political risks in developed economies has led markets to revisit the perceived notion that emerging countries’ economies and political set-ups are inherently less stable and more risky.

Put differently, developed market economies remain just about strong enough to drive EM growth but are sufficiently weak and susceptible to endogenous shocks to highlight the attractiveness of EM assets. The question is what, if anything, is likely to destabilise this fine balance.

The two events which have seriously rattled EM assets, including currencies, in the past year had their epicentres in the world’s two largest economies: the PBoC’s renminbi “devaluation” in August and subsequent government tinkering with Chinese equity markets and the US Fed’s first hike in a decade on 16th December.

An EM crisis is still more likely to have its birthplace in the US or China than Europe for example, in my view, with EM asset prices in the past 18 months relatively resilient to made-in-Europe stresses.

US GDP growth remains unspectacular, with the manufacturing sector weighed down by a strong dollar, while China’s economy is still dependent on loose credit policy and vulnerable because of banks’ growing non-performing loans.

While both the Fed and Chinese policy-makers have seemingly learnt lessons from prior misjudgements, in both countries the risk of policy mistakes remains very much alive. Moreover, the US presidential elections scheduled for 8th November present a significant event-risk to emerging markets and their currencies.
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Chinese PMI very sensitive to underlying economic activity

The Federal Reserve has 23 more days worth of data and market developments to analyse before its policy meeting.

China’s official and (unofficial) Caixin manufacturing data for May will be released tomorrow and Friday before the usual deluge of monthly economic indicators. Markets tend to give weight to the early release of PMI data in the world’s second largest economy and the question is whether this is justified.

Looking at data for the past decade, there was a good correlation up till about 2012 between China’s official manufacturing PMI and exports, imports, industrial output, retail sales and GDP, with the added advantage of the PMI leading by a couple of months. However, since then these correlations on the surface appear to have broken down, even if we use the sub-components of headline PMI.

The main issue is seemingly one of calibration. Since 2012, the official manufacturing PMI has only fallen marginally in a narrow 49.0-51.7 range while monthly economic indicators have weakened considerably. If we shorten the time scale, the PMI’s correlations with monthly data again look reasonable.

Markets need to take into account this increased sensitivity of the PMI data, as small moves may ultimately be associated with significant changes in underlying economic activity.

Even so, the official manufacturing PMI has seemingly over-estimated China’s economic strength in recent months. An alternative view point is that monthly economic indicators are about to rebound quite sharply.

The unofficial Caxin manufacturing PMI data – which have been more volatile than the official measure – and the official non-manufacturing PMI have even over longer time-frames been somewhat better correlated with monthly economic indicators. They too point to a rebound in economic activity in coming months.

Please see Appendix for complete set of correlation charts.

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More EM central banks to join rate-cutting party

The Reserve Bank of India (RBI) surprised the market with a larger-than-expected 50bp cut to its policy rate to 6.75% at its scheduled meeting on Monday. This should perhaps not have come as such a surprise given the collapse in WPI and CPI-inflation, resilient rupee nominal effective exchange rate and regional and global growth slowdown, not to mention the Fed’s recent decision to delay its hiking cycle once again. Read more

Chinese trade tantrum

Chinese trade rebounded in June, but from a very low base and overall Asian exports remain depressed. The temptation is to think that Chinese policy-makers will sacrifice a robust renminbi in order to spur economic growth but I expect the PBoC to favour a stable currency while the government focuses on pump-priming domestic demand.

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Emerging Markets falling between the cracks (and BRICS)

The distinction between developed, emerging, in transition and frontier economies has in the past 10-15 years become somewhat more blurred and arguably misleading, in my view, for a number of reasons. For starters it’s a very subjective definition. Secondly, it’s a fluid set of groupings. Finally sell-side institutions (and in some cases countries themselves) have been conservative in redefining the boundaries.  Read more