Global Investing

After bumper 2012, more gains for emerging Europe debt?

By Alice Baghdjian

Interest rate cuts in emerging markets, credit ratings upgrades and above all the tidal wave of liquidity from Western central banks have sent almost $90 billion into emerging bond markets this year (estimate from JP Morgan). Much of this cash has flowed to locally-traded emerging currency debt, pushing yields in many markets to record lows again and again. Local currency bonds are among this year’s star asset classes, returning over 15 percent, Thomson Reuters data shows.

But the pick up in global growth widely expected in 2013 may put the brakes on the bond rally in many countries – for instance rate hikes are expected in Brazil, Mexico and Chile. One area where rate rises are firmly off the agenda however is emerging Europe and South Africa, where economic growth remains weak. That is leading to some expectations that these markets could outperform in 2013.

There have already been big rallies. Since the start of the year, Turkey’s 10 year bond has rallied by 300 basis points; Hungary’s by almost 400 bps; and Poland’s by 200 bps. So is there room for more.

Analysts at Societe Generale reckon central banks in emerging countries – particularly in Europe -  will ease policy further next year though they do not expect the same magnitude of gains as in 2012. Swaps markets are pricing 125 bps in rate cuts in Hungary and Poland over the next six months and around 50 bps in Russia, Turkey and South Africa.

Gaelle Blanchard, emerging markets strategist at the bank says:

There is a little bit of room for more downside on the yields (in emerging Europe), at least at the beginning of the year... There are some differentiations on countries but clearly the easing cycle is not over in most countries. In Hungary there are more rate cuts in the pipeline… In Turkey, they have done lots and lots already but I think the central bank is still dovish.

Fitch’s Xmas gift for Hungary leaves analysts agog

Hungary’s outlook upgrade to stable from positive by Fitch was greeted with incredulity by many analysts. Benoit Anne at Societe Generale wonders if the decision had anything to do with the Mayan prophecy that proclaiming the end of the world on Dec. 21:

What is the last crazy thing you would do on the last day of the world? Well, the guys at Fitch could not find anything better to do than upgrading Hungary’s rating outlook to stable. Now, that really makes me scared.

A bit brutal maybe but the point Anne wants to make is valid — nothing fundamental has changed in Hungary — its GDP growth and debt numbers are looking as dire as before and the central bank is still subject to political interference.

Hungary’s forint and rate cut expectations

A rate cut in Hungary is considered a done deal today. But a sharp downward move in the forint  is making future policy outlook a bit more interesting.

The forint fell 1.5 percent against the euro on Monday to the lowest level since July and has lost 2.6 percent this month. Monday’s loss was driven by a rumour that the central bank planned to stop accepting bids for two week T-bills. That would effectively have eliminated the main way investors buy into forint in the short term.   The rumour was denied but the forint continues to weaken.

Analysts are not too worried, attributing it to year-end position squaring. Benoit Anne, head of EM strategy at Societe Generale, points out the forint is the world’s best performing emerging currency of 2012 (up  11.3 percent against the dollar). Given the state of the economy (recession) and falling inflation, the forint move will not deter the central bank from a rate cut, he says.

Emerging Policy-More interest rate cuts

A big week for central bank meetings looms and the doves are likely to be in full flight.

Take the Reserve Bank of India, the arch-hawk of emerging markets. It meets on Tuesday and some, such as Goldman Sachs, are predicting a rate cut as a nod to the government’s reform efforts. That call is a rare one, yet it may have gained some traction after data last week showed inflation at a 10-month low, while growth languishes at the lowest in a decade. Goldman’s Tushar Poddar tells clients:

With both growth and inflation surprising on the downside relative to the RBI’s forecast, there is a reason for the central bank to move earlier than its previous guidance.

The BBB credit ratings traffic jam

Adversity is a great leveller. Just look at the way sovereign credit ratings in the developed and emerging world have been converging ever since the credit crisis erupted five years ago. JPMorgan  has crunched a few numbers.

Few were surprised last week by S&P’s decision to cut the outlook on Britain’s AAA rating to negative. That gold-plated rating is becoming increasingly rare — according to JP Morgan, just 15 percent of global GDP now rates AAA with a stable outlook — a whopping comedown from 50 percent in 2007. Only 13 developed economies are now rated AAA, compared to 21 before the crisis. And only one, Australia, now has a higher rating (AAA) than in 2007 — 16 of its peers have suffered a total of 129 downgrades in this period.  With 20 rich countries on negative outlook, more downgrades are likely.

Emerging sovereigns, on the other hand, have enjoyed 189 upgrades (43 percent of these were moves into investment grade). That has caused what JPM dubs “a traffic jam”  in the triple B ratings area, with 20 percent of world GDP now rated at this level, compared to 8 percent in 2009.

Weekly Radar: Elections and housing in last big week of 2012

So an extra dose of medicine from the Fed on Wednesday helps smother global market volatility further into the yearend — even though naming an explicit 6.5% unemployment rate could well send Treasury bond volatility soaring as the current 7.7% rate likely approaches that level in 2014 just as the Fed low-rate pledge expires. Not a story for early next year maybe, but…

More nose-against-the-windshield, the busy end to this week – with the EU Summit today and December’s flash PMIs tomorrow – makes it difficult to clear the decks yet for yearend — at least not as much as market pricing and volumes would suggest. Moves to some form of EU banking union are already in the mix from Brussels, however, so another plus at the margins perhaps.

And looking back over the past week — who’d have thought we could still be surprised by an upset in Italian politics? It was the only real significant pre-Fed news of the past week and maybe packed more of a initial punch that it warranted as a result. But for all the interest in Monti stepping aside and Silvio’s attempt to return, there was no really big shift in picture already in front of investors. Ok, so the election is now likely in February not March/April and no one wants to write off Berlusconi completely. But he’s still more than 10 points adrift in polls and Monti himself may well stand for PM in the election too. In short, it adds some political risk at the edges, but if you were happy to hold or buy more Italian bonds before this (still a big ‘if’), then all that really changed for investors is they got a better yield at this week’s relatively successful auction.

Loans to emerging markets lose shine

(By Alice Baghdjian)

Ravaged by the financial crisis and struggling with new capital regulations, European banks have scaled back overseas assets and slimmed loan books. Cordiant Capital, a fund focused on private loans to emerging markets, cites data this week from the Bank for International Settlements (BIS), which shows that syndicated loans to emerging economies fell by 30 percent to $245.3 billion in the year to end-September.
That’s down from $353 billion in the comparable 2011 period.

New loans to Asia, normally the largest recipient of developed market bank lending, fell by 27 percent over the last 12 months compared with the same period in 2010-2011.

But it was lending to emerging eastern European economies that fell most markedly, cut by more than a third.

African growth if China slows

The  apparent turnaround in Africa’s fortunes over the past decade has been attributed to the rise of China and its insatiable appetite for African commodities. So African policymakers, like those everywhere, will have been relieved by the recent uptick in Chinese economic data.

But is Africa’s dependence on China exaggerated?  A hard landing in the Asian giant will be an undoubted setback for African finances but according to Fitch Ratings.  it may not be a disaster.

Fitch analyst Kit Ling Leung estimates that if China’s economy grows at below-forecast rates of 5 percent in 2013 and 6.5 percent in 2014, African real GDP growth will slow by 90 basis points.  So a 3 percentage point drop in Chinese growth will lead to less than a 1 percentage point hit to Africa. Countries such as Angola will take a harder hit due to oil price falls but others such as Uganda, which import most of their energy, may even benefit, Yeung’s exercise shows.

Yuan bond market: slow to flower in London

London’s offshore yuan bond market, launched to much fanfare last October,  is still struggling to get many deals off the ground. Banks and authorities from Britain, China and Hong Kong met last week in London at their twice-yearly forum to discuss reasons. Liquidity, or lack of it, was deemed to be the main hurdle.

China Construction Bank last month became the first Chinese borrower to launch a London-listed bond. But there have only been a handful of London bonds this year, as the nascent offshore market continues to lag far behind Hong Kong.

Spencer Lake, co-head of global markets at HSBC, told a briefing last week:

We have not yet seen the competitive pricing such that you can only issue in London.  There are probably 50 entities around the world that would love to come to the market tomorrow, but we still need to see more trading, more liquidity build up.

Corruption and business potential sometimes go together

By Alice Baghdjian

Uzbekistan, Bangladesh and Vietnam found themselves cheered and chided this week.

The Corruption Perceptions Index, compiled by Berlin-based watchdog Transparency International, measured the perceived levels of public sector corruption in 176 countries and all three found their way into the bottom half of the study.

Uzbekistan shared 170th place with Turkmenistan (a higher ranking denotes higher perceived corruption levels) . Vietnam was ranked 123th, tied with countries like Sierra Leone and Belarus, while Bangladesh was 144th.