An Offset? Less Risk of a Fed Rate Hike Later this Year. There may be one medium-term offset for EM to the above risk-off results of the Leave vote.
With Leave ushering in, at least, a temporary period of heightened global market and economic uncertainty and a stronger dollar, the FOMC will need time to assess the broad consequences of the ‘Leave’ vote before making further changes in monetary policy. After the referendum vote, therefore, our US economists have withdrawn their call for a 25bp rise in fed funds at the September FOMC, although a December rate rise may still be ‘on the table’. For now, we also maintain our US GDP forecasts of +1.7% this year and +2.5% in 2017.
While the Leave result is likely to spell a stronger dollar and weaker US exports – negative for growth – this may be offset by even lower long-term interest rates – a positive for the economy – leaving the macro outlook broadly unchanged. This change in Fed view, after the Leave vote, may act as a type of ‘automatic stabilizer’ for financial markets, notably for risky assets, Therefore, while the immediate effect of the vote should be negative for EM equities, with defensive positions likely to outperform as laid out in this note, another likely delay in Fed tightening should, before long, put a floor under EM equities and other risk assets. It is not quite ‘buy the dip’ (in EM) after the vote – as it may be a significant ‘dip’ – but we think investors should look for an opportunity to buy into weakness before too long and to raise their weights again in higher risk, higher-beta EM equities.
That effort to find some sort of positive Brexit angle is via Geoff Dennis and team at UBS. It comes at the end of a more downbeat note that points out the broader EM implications of a short-term risk-off mentality in global markets, while still managing to find some glimmers of hope, like: Read more
Do click to enlarge, any complaints to UBS, where credit also resides:
The man who knows about the size of central bank reserves needed to defend domestic economic stability says this on Thursday at an economic forum in Sri Lanka (via Bloomberg):
“China has a major adjustment problem,” Soros said. “I would say it amounts to a crisis. When I look at the financial markets there is a serious challenge which reminds me of the crisis we had in 2008.”
Which is apropos because, via Reuters, on Thursday:
China FX reserves fall $512.66 bln in 2015, biggest annual drop on record – RTRS
BEIJING, Jan 7 (Reuters) – China’s foreign exchange reserves, the world’s largest, fell $107.9 billion in December to $3.33 trillion, the biggest monthly drop on record, central bank data showed on Thursday. The December figure missed market expectations of $3.40 trillion, according to a Reuters poll. China’s foreign exchange reserves fell $512.66 billion in 2015, the biggest annual drop on record. The value of its gold reserves stood at $60.19 billion at the end of December, up from $59.52 billion at the end of November, the People’s Bank of China said on its website. Gold reserves stood at 56.66 million fine troy ounces at the end of December, up from 56.05 million at end-November.
From the latest BIS quarterly review, in particular its bit on dollar credit to EMs (our emphasis):
[Fed largesse]… drove a surge in issuance by both long-standing issuers and new ones (Mizen et al (2012)). Petrobras, among the largest issuers, exemplifies the former. To pay the development costs for offshore oil in the face of cash flows weakened by low domestic administered energy prices, this partially state-owned Brazilian oil company ramped up its dollar debt in 2009–14, with multitranche offerings of no less than $8 billion and $6 billion highlighting the ready supply of institutional funds.11 Many African sovereigns exemplify the new issuers. Would-be underwriters courted them, mindful that pension funds and mutual funds sought to diversify away from the sovereign debt of the major economies in their portfolios. Ghana, Kenya, Rwanda and Zambia all found ready markets.
At the time of writing, deals are still going through even for non-investment grade sovereign issuers. Ghana, Pakistan, Sri Lanka and Zambia all issued in 2015, albeit in smaller amounts or at higher spreads than they desired or had previously achieved. Ethiopia debuted at end-2014, while Angola did so in November 2015.
Nevertheless, dollar bonds outstanding have grown more slowly in 2015 than in 2013 and 2014.
Which came first the commodity fall or the local currency collapse? And, more importantly, how far through the commodity supply/ demand adjustment are we?
The suggestion here from SocGen’s Kit Juckes and friends is that the causality runs from commods to currencies and that there is still a lot of pain to come:
My colleague Michael Haigh has done a lot of work on the overall state of supply and demand in commodity markets, and he makes one very striking observation: For all the fall in the prices of many industrial and agricultural commodity prices in USD terms, the prices in the currency of the biggest producers have not necessarily fallen much. Sugar prices have fallen by over 8% this year in USD terms, but the Brazilian real has fallen by 29%. Copper prices have collapsed, down over 20%, but the Chilean peso is down 15% and trying hard to keep up. Gold is down 9%, but the South African rand has fallen by twice as much and in rand terms, the gold price is near its highs. The fall in iron ore prices (over 30%) is twice the fall by the Australian dollar, but you get the picture (Charts 1 and 2).
We might have to start an “x is less terrifying” series.
Consider this on EM FX…
At FT Alphaville we’ve flagged concerns about the perfect storm of declining petrodollar/sweatdollar recycling flows, a Fed tightening schedule, and a regulatory environment increasingly averse to cross-border repos and funding, with potential unintended (or perhaps intended but grossly under appreciated) effects for offshore dollar liquidity.
Why dollar liquidity, not euro, sterling or yen? Well, obviously, because the dollar remains the premier global reserve asset. Read more
Xinhua’s words, so it’s official:
Jim Reid at Deutsche assesses the damage so far. As he says, this has something of a taper tantrum feel to it but seperating out China from Fed fear is a tough job even if given “that the odds of a September hike are fading again (32% this morning, down 16% over the last 48 hours)” it seems “China and the impact on EM is the overriding driver”.
With our emphasis:
One of the big problems with China’s FX move is that although they’ve ‘only’ seen a 3% currency fall (in the onshore Yuan) since their announcement last week, others have subsequently followed suit either deliberately or via market [and oil based] pressure. The following countries have seen their currency depreciate at least 4% since last Monday (and using last night’s closing prices): Kazakhstan (leading the way with a huge 26% devaluation following the removal of the trading band), Russia, Ghana, Guinea, Colombia, Belarus, Turkey, Malaysia and Algeria. In fact, if we extended the analysis to include those that have seen at least a 3% depreciation then the number of countries hits 17 and unsurprisingly all sit in the EM bracket.
This is a snapshot of the Peruvian economy’s growing dependency on central bank intervention by way of BNP Paribas on Tuesday,
With apologies for the angelic imagery, here’s BNP Paribas on Wednesday (our emphasis):
In our analysis, six EM sovereigns are at risk of becoming fallen angels this year or next. Three of these we consider ‘high risk’. As much as USD 259bn of sovereign and corporate bonds is at high risk of being cast down into speculative grade perdition. This accounts for 9% of all EM bonds outstanding (USD 2.87trn).
… it is little surprise that the peak of credit quality for EM appears to be over. After having hit the BBBthreshold in 2013 and improving another 1/6th of a notch over2013 (Figure 2), the credit quality of the EM benchmark has begun to slide downward. Already it has lost 1/6th of a notch and we forecast the index to slide another half notch by the year end.
Money managers have been stung hard this year due to US government bonds not performing the way their traditional mean-reverting strategies suggested they would. Taper was supposed to imply sell-off. That didn’t happen. And now everyone is trying to understand why not.
At FT Alphaville we’ve presented the flow explanation on a number of occasions. The theory is that taper talk prompts dumb money to sell safety, and the smart money — which knows there’s no such thing as underpriced principal safety these days and that taper implies risk-off — to pile into safety at an even faster rate.
In this theory the whole process is then exacerbated by a feedback loop. Sellers of safety buy risky assets, like emerging market debt, instead. But the sellers/issuers of that debt then recycle that cash back into safe US dollar securities, rather than goods or services in the emerging market. So every risk-on signal from the Fed only ends up creating more buyers for dollar denominated bonds. Read more
It’s been a tough day for EM. But just in case you were tempted to bundle the whole region together to make a sweeping generalisation about future performance, it’s worth reading through the following note from Capital Economics on Friday.
As they explain, EM is no longer the place it used to be. There are clear divisions emerging, and understanding which countries influence into each other more directly than others matters now more than ever:
Market turbulence in Turkey, Ukraine and now Argentina has led to talk of a new crisis sweeping emerging markets (EMs). But the emerging world has become a far more diverse place over the past decade. The real lesson from recent events is that the need for investors to discriminate between individual EMs has never been greater.
That’s what this chart, released on Friday by Citi’s municipal bond team, apparently suggests:
In a whopping report out Monday, Citi’s Willem Buiter and Ebrahim Rahbari call time on ‘Emerging Markets’ and ‘BRIC’ labels.
And not a moment too soon, we reckon. Read more
Barclays Capital may not be too hot on some emerging-market credits (ahem, Hungary) but they certainly make a stirring case for EM bonds overall.
Or rather, they make a stirring case for the rise of emergification. Read more
While Europe’s sovereign debt crisis has grabbed the attention of global markets, inflation is again clawing its way back in emerging economies, as Philip Poole of HSBC notes on the FT’s Beyond Brics blog. China provided more evidence of this trend on Tuesday, with the release of CPI data for April which showed inflation continuing to move higher.
As the FT reported, both Chinese inflation and housing price rises continue to quicken, with consumer price inflation rising to 2.8 per cent in April from 2.4 per cent the month before – its highest in 18 months, although still short of the government’s 3 per cent target – while factory-gate inflation jumped to 6.8 per cent from 5.9 per cent. Read more
Alongside sterling’s weakness and a smattering of M&A, one of the reasons the UK has shown a clean pair of heels to its peers in Europe since the start of the year is its relative internationalisation.
By that, we mean the growing number of UK-listed companies which generate a large chunk of their income overseas, particularly in the fast-growing emerging markets of Asia and Latin America. Read more