Global Investing

Rand: the only way is south

Any hopes of policy support for the rand from the South African Reserve Bank (SARB) have vanished.  The currency fell 1 percent after yesterday’s SARB meeting where  Governor Gill Marcus made it clear she would not be standing in the way of the rand’s move south. It is now trading at 9.32 per dollar.

More losses look likely, especially if foreign bond investors throw in the towel, a move which analysts at Societe Generale liken to “the market equivalent of a volcanic eruption”. Foreigners, after all, own more than 36 percent of the 1 trillion-rand market in local currency sovereign bonds.

Bearishness appears to have escalated since a Reuters poll of 32 analysts conducted in early-March.  Back then the mean forecast for the rand’s exchange rate in a month’s time was 8.94 per dollar, the poll found.  The 12-month mean forecast was for 8.787.

In a note this morning, Societe Generale said there was  “considerably more pain coming now that the central bank is not ready to provide some sort of backstop”.

Clearly, markets had expected a stronger statement from Marcus, who did recently say she thought the rand move looked “overdone”.  But the SARB has typically taken a more laissez-faire approach towards currency weakness. And right now there is another reason for this attitude — there is very little ammunition to mount any sort of defence of the rand.

Rotation schmotation

We’re at risk of labouring this point, but there has been some more evidence that this year’s equity rally has not been spurred by a shift away from fixed income. The latest data from our corporate cousins at Lipper offer pretty definitive proof that there has been no Great Rotation, at least not from bonds to stocks.

Worldwide mutual fund flows numbers for February showed an overall move into equity funds of more than $22 billion, and a net flow to bond funds of about half that. Over 3 months it’s a similar story, with a net inflow to equities of about $84 billion while bond funds sit close behind at about $75 billion. Little wonder then that there is some evidence at least of movements out of money market funds.

In fact, maybe HSBC called it about right last week. In a note, their cross-asset strategists reckoned a pick-up in economic growth might support a ‘minor’ cyclical rotation into equities from bonds, but a longer-term structural shift between the two asset classes as part of a ‘Great Rotation’ was less likely.

Dollar drags emerging local debt into red

Victims of the dollar’s strength are piling up.

Total returns on emerging market local currency bonds dipped into the red for the first time this year, according to data from JPMorgan which compiles the flagship GBI-EM global diversified index of domestic emerging debt. While the EMBI Global index of sovereign dollar debt has already taken a hit the rise in U.S. yields, local bonds’ problems are down to how EM currencies are performing against the dollar.

JPMorgan points out that while bond returns in local currency terms, from carry and duration, are a decent 1 percent, that has been negated by the 1.3 percent loss on the currency side. With the dollar on the rampage of late  (it’s up almost 4 percent in 2013 against a grouping of major world currencies) that’s unsurprising. But a closer look at the data reveals that much of the loss is down to three underperforming markets — South Africa, Hungary and Poland. These have dragged down overall returns even though Asian and Latin American currencies have done quite well.

The graphic below shows South African local debt bringing up the bottom of the table, with the FX component of returns at around minus 9 percent  In rand terms however the return is still in positive territory, but only just. Hungary and Poland fare only slightly better.

Weekly Radar: Cyprus hogs the headlines but contagion fears limited

CYPRUS BRINKMANSHIP/BERNANKE IN LONDON/BRICS SUMMIT/MARCH CONSUMER SENTIMENT IN EUROPE/JAPAN INFLATION-JOBS-PRODUCTION/US-UK Q4 GDP REVISIONS

Cyprus has hogged the headlines since Friday, with bank closures now extended to a full week as they try to sort out a very messy bailout - made worse by domestic policy missteps over taxing bank deposits. As with Italy’s elections, the saga certainly challenges any market assumption that the euro crisis had abated for good and it’s also loaded with a series of potential precedents – not least the biggest taboo of them all, a euro exit. This is where the politics, brinkmanship and smoke-filled-rooms come in.  Yet as Cyprus is so small and its banks in such a peculiar setup – given the scale of Russian and other foreign depositors – the euro group, ECB and IMF appear determined not to be pressured into a bailout above the already gigantic 60 percent of GDP.

And, as with Greece last year, they will likely stand firm and leave any decision to exit up to the Cypriots themselves. You can’t rule out that they may choose to go and regional risks rise somewhat as a result. But if the islanders are genuinely worried about a 6-10% tax on deposits, they may also think long and hard about the chance those deposits would be redenominated into a heavily devalued Cypriot pound. Just ask the Argentinians what that feels like. A deposit haircut may seem a like a half-decent deal by comparison if some other mix of Russian loans, pension raids or securitised future gas revenues doesn’t stack up.

Here comes the real

Inflation is finally biting Brazilian policymakers. The real strengthened around 1.5 percent last week without triggering the usual shrill outcries from government ministers. Nor did the central bank intervene in the currency market even though the real is the best performing emerging currency this year. The bank in fact shifted towards a more hawkish policy stance during its March meeting, a move that seems to have had the blessing of the government.

Friday’s data showed the benchmark consumer price index, IPCA,   up 0.6 percent for a year-on-year inflation rate of 6.31 percent. President Dilma Rousseff, who faces elections next year, took to the airwaves soon after to reassure voters about her commitment to taming inflation, announcing a series of tax cuts. That effectively is a signal that there is now no political constraint on raising interest rates. According to the political risk consultancy, Eurasia:

If the government doesn’t enact measures during the first half of this year to anchor inflationary expectations, Rousseff would run one of two risks. She would either run the risk of inflation starting to eat into the disposable income of families in a manner that could hurt her politically, or relatedly, put the central bank in a position of having to raise interest rates more aggressively later in the year to control inflation with more negative repercussions to growth.

Emerging Policy-”Full stop” in Poland but a start in Mexico?

An action-packed week for emerging monetary policy.

First we had Poland stunning markets with a half-point rate cut when only 25 bps was priced. Governor Marek Belka said the double-cut marked a “full stop”  after several cuts.  Then came Brazil which kept rates on hold at 7.25 but turned hawkish after spending over 18 months in dovish mode. (Rates stayed on hold in Indonesia and Malaysia).

In Brazil, it was high time. Inflation and inflation expectations have been rising for a while, the yield curve has been steepening and anxiety has grown, not only about the central bank”s commitment to controlling inflation but also about its independence.  Whether the central bank will actually start a hiking cycle anytime soon is another matter. Barclays reckon it will, predicting three consecutive 50 bps rate hikes starting from April. But analysts at Societe Generale are among those who are betting on flat rates for now. They point out that since the meeting, the Brazilian yield curve has moved to its flattest in a year and the 2017 inflation breakevens (the difference between the yields on fixed-rate and inflation-linked bonds of similar maturity) have fallen more than 50bps:

This implies that simply by showing a small amount of vigilance, a great deal of structural inflation concerns seem to have dissipated.

Argentina back in court

Argentina squares off today in a U.S. Appeals court with the so-called holdout creditors who are demanding $1.3 billion in payments on defaulted bonds. A decision will probably take a few days but supporters of both sides have been mustering.

Emails have been pouring into journalists’ inboxes thick and fast from the Argentine Task Force, a lobby group that wants Argentina to settle with bondholders and identifies its goal as “pursuing a fair reconciliation of of the Argentine debt default”.  And yesterday, a noisy pots-and-pans protest was held outside the London offices of Elliot Associates (the parent company of one of the two hedge fund litigants)  by groups supporting Argentina in its battle against those it terms “vulture funds”.  Nick Dearden, director of the Jubilee Debt Campaign, a group that calls for cancelling poor countries’ debts, says:

If the vulture funds are allowed to extract their pound of flesh from Argentina today, we will see a proliferation of vulture funds in Europe tomorrow.

Time running out for Hungarian bonds?

Could Hungary’s run of good luck be about to end?

Despite controversial policies, things have gone the country’s way in recent months — the easing euro crisis and abundant global liquidity saw investors flock to high-yield emerging markets such as Hungary and also allowed it to tap international capital for a $3.25 billion bond. It has slashed interest rates seven times straight, cutting them this week to a record low 5.25 percent. The result is an increased reliance on international bond investors. Foreigners’ share of the Budapest bond market  is almost 50 percent, among the highest percentages in emerging markets.

But analysts at Unicredit write that both markets and economic data had validated rate cuts in 2012, which may not be the case any more. Annual headline inflation fell from 6.6% in September 2012 to 3.7% in January 2013 while the economy contracted 1.7% last year. As a result, net foreign buying of Hungarian bonds rose  in the second half of 2012 to 837 billion forints (an average daily rate of almost 6 billion forints), they note.  Markets are pricing at least 3 more cuts, that will take the rate to 4.5 percent.

But support from foreigners is ebbing. Since the beginning of the year, Unicredit points out, foreign investors have cut holdings of government bonds by 236.8 billion forints (average daily outflow of 6.1 billion forints). Moreover, the most recent rate cuts have failed to fully translate into bond yield corrections, they say.  While the short-dated 2-5 year segment of the curve dropped 23-40 basis points, the belly (the middle) of the curve dipped by only 9-24 bps and longer-dated yields over 10 years have risen by around 18 bps. And the fall in inflation too could be a thing of the past if the government resorts to tax hikes in order to meet the deficit target of 2.7% of GDP  — that would persuade the European Union to lift the excessive deficit procedure it has triggered against Hungary for repeated budget deficit overshoots.

Twenty years of emerging bonds

Happy birthday EMBI! The index group, the main benchmark for emerging market bond investors, turns 20 this year.  When officially launched on Dec 31 1993, the world was a different place. The Mexican, Asian and Russian financial crises were still ahead, as was Argentina’s $100 billion debt default. The euro zone didn’t exist, let alone its debt crisis. Emerging debt was something only the most reckless investors dabbled in.

To mark the upcoming anniversary, JPMorgan – the owner of the indices – has published some interesting data that shows how the asset class has been transformed in the past two decades.  In 1993:
- The emerging debt universe was worth just $422 billion, the EMBI Global had 14 sovereign bonds in it with a market capitalisation of $112 billion.
- The average credit rating on the index was BB.
- Public debt-to-GDP was almost 100 percent back then for emerging markets, compared to 69 percent for developed markets.
- Forex reserves for EMBI countries stood at $116 billion
- Per capita annual GDP for index countries was less than $3000.
Now fast forward 20 years:
- The emerging debt universe is close to $10 trillion, there are 55 countries in the EMBIG index and the market capitalisation of the three main JPM indices has swollen to $2.7 trillion.
- The EMBIG has an average Baa3 credit rating (investment grade) with 62 percent of its market cap investment-grade rated.
- Public debt is now 34 percent of GDP on average in emerging markets, while developed world debt ratios have ballooned to 119 percent of GDP.
- Forex reserves for EMBIG members stand at $6.1 trillion
- Per capita annual income has risen 2.5 times to $7,373.

What next? The thinking at JPM seems to be that the day is not far off when a country “graduates” from the EMBI and joins the developed world.  To be excluded from the EMBI group of indices, a country’s gross national income must exceed the bank’s “index income ceiling” (calculated using World Bank methodology) for three years in a row or have a sovereign credit rating of A3/A- for three consecutive years.

Emerging Policy-More cuts and a change of governors in Hungary

All eyes on the Hungarian central bank this week.  Not so much on tomorrow’s policy meeting (a 25 bps rate cut is almost a foregone conclusion) but on Friday’s nomination of a new governor by Prime Minister Viktor Orban.  Expectations are for Economy Minister Gyorgy Matolcsy to get the job, paving the way for an extended easing cycle. Swaps markets are currently pricing some 100 basis points of rate cuts over the coming six months in Hungary — the question is, could this go further? With tomorrow’s meeting to be the last by incumbent Andras Simor, clues over future policy are unlikely, but analysts canvassed by Reuters reckon interest rates could fall to 4.5 percent by the third quarter, compared to their prediction for a 5 percent trough in last month’s poll.

A rate cut is also possible in Israel later today, taking the interest rate to 1.5 percent. Recent data showed growth at a weaker-than-expected 2.5 percent in the last quarter of 2012 while inflation was 1.5 percent in January, at the bottom of the central bank’s target range.  But most importantly, according to Goldman Sachs, the shekel has been strengthening, having risen 7 percent against the dollar since November and 6.8 percent on a trade-weighted basis in this period. That could prompt a rate cut, though analysts polled by Reuters still think on balance that the BOI will keep rates unchanged while retaining a dovish bias. A possible reason could be that house prices — a sensitive issue in Israel — are still on the rise despite tougher regulations on mortgage lending.