Global Investing

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.

Second, the real has appreciated almost 5 percent this year on rate hike expectations and inflation. A rate rise at a time when most other central banks are lowering rates, will draw more inflows to the real, something the government is unlikely to be happy about.

Mexico’s policy meeting later on Friday could be very interesting. The Banxico has kept interest rates on hold at 4.50 percent for four years but could finally opt for a cut. Five of the 21 analysts polled by Reuters predict a 50 bps cut to a record low 4 percent.

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.

 

Bond investors’ pre-budget optimism in India

Ten-year Indian bond yields have fallen 30 basis points this year alone and many forecast the gains will extend further. It all depends on two things though — the Feb 28 budget of which great things are expected, and second, the March 19 central bank meeting. The latter potentially could see the RBI, arguably the world’s most hawkish central bank, finally turn dovish.

Barclays is advising clients to bid for quotas to buy Indian government and corporate bonds at this Wednesday’s foreigners’ quota auction (India’s securities exchange, SEBI, will auction around $12.3 billion in quotas for foreign investors to buy bonds). Analysts at the bank noted that this would be the last auction before the central bank meeting at which a quarter point rate cut is expected. Moreover the Reserve Bank of India will signal more to come, Barclays says, predicting 75 bps in total starting March.

That is likely to be driven first by recent data — inflation in January was at a three-year low while growth has slowed to a decade low.  Barclays notes:

Russian companies next stop for Euroclear

The excitement continues over Russian assets becoming Euroclearable.   Euroclear’s head confirmed last week to journalists in Moscow that corporate debt would be the next step, potentially becoming eligible for settlement within a month. Russian equities are set to follow from July 1, 2014.

What that means is foreign investors buying Russian domestic rouble bonds will be able to process them through the Belgium-based clearing house, which transfers securities from the seller’s securities account to the securities account of the buyer, while transferring cash from the account of the buyer to the account of the seller.

The Euroclear effect in terms of foreign inflows to Russian bonds could be as much $40 billion in the 2013-2014 period, analysts at Barclays estimated earlier this month.  Yields on Russian government OFZ bonds should compress a further 50-80 basis points this year, says Vladimir Pantyushin, the bank’s chief economist in Moscow, adding to the 130 bps rally in 2012. Foreigners’ share of the market should double to 25-30 percent Pantyushin says, putting Russia in line with the emerging markets average.

A (costly) balancing act in Hungary

A bond trader in London is still marvelling at the market’s willingness to snap up a Eurobond from Hungary, calling it a country with “a policy mix so unorthodox even Aunty Christine won’t lend to them”.  But Hungary’s probable glee at bypassing the IMF and “Aunty Christine”  with $3.25 billion in two bonds that were almost four times oversubscribed, is probably short-sighted.

Hungary needs to raise the equivalent of $23.4 billion this year to repay maturing debt. The bond placement will enable Hungary to easily meet the hard currency component of this, and it has been enormously successful in luring buyers to domestic debt markets.  Such has been the demand for Hungarian bonds in recent months that foreigners’ holdings of forint-denominated government debt are at a record high of over 45 percent.

The success does not necessarily represent a thumbs-up for Prime Minister Viktor Orban’s policies but is more likely due to the yield Hungary paid — well over 5 percent for five and 10-year cash. In dollar terms that is not to be sneezed at, especially at a time when liquidity is abundant and the yield on mainstream dollar assets is low. The same reason is behind the demand for forint bonds, where Hungary pays over 5 percent on one-year paper. An IMF loan would have been far cheaper. (The rate for a standby loan of the kind Hungary had is tied to the IMF’s Special Drawing Rights (SDR) interest rate. Very large loans carry a surcharge of 200 basis points)

Russia’s consumers — a promise for the stock market

As we wrote here last week, Russian bond markets are bracing for a flood of foreign capital. But there appears to be a surprising lack of interest in Russian equities.

Russia’s stock market trades on average at 5 times forward earnings, less than half the valuation for broader emerging markets. That’s cheaper than unstable countries such as Pakistan or those in dire economic straits such as Greece. But here’s the rub. Look within the market and here are some of the most expensive companies in emerging markets — mostly consumer-facing names. Retailers such as Dixy and Magnit and internet provider Yandex trade at up to 25 times forward earnings. These compare to some of the turbo-charged valuations in typically expensive markets such as India.

A recent note from Russia’s Sberbank has some interesting numbers on Russia’s consumer potential. Sberbank tracks a hypothetical Russian middle class family, the Ivanovs, to see how consumer confidence is shaping up (According to SB their data are broader in scope than the government’s official consumer confidence survey).

Weekly Radar: Currency warriors meet in Moscow

G20/EUROGROUP/EURO Q4 GDP/STATE OF THE UNION/BOJ/UST, GILT AND ITALY BOND AUCTIONS/EUROPEAN EARNINGS

Hiccup. February has so far certainly brought a more sober, if healthier, perspective to world markets. Global stocks are off about half a percent this week, letting the air out gently from January’s over-inflated 5 percent surge. The focus is back on Europe, where the threat of a euro FX overshoot (in the face of LTRO paybacks and rising euro interest rates alongside stepped-up “global currency wars”) has fused with a plethora of unresolved national debt conundrums and a stream of ‘event risks’ on the region’s calendar. Euro stocks have retreated to December levels as the currency move and fresh political angst has taken the wind out of earnings and growth projections after such a steep rally over the past six months. Name anything you want – the tightening race for this month’s Italian elections and Monte di Paschi scnadal there, a delayed Cyprus bailout and elections there this month, the Irish promissory note standoff with the ECB etc etc – when things turn, they all these get amplified again even if none really are likely to be systemic threats in the way we’d become used to over the past two years. The slight backup in Italian/Spanish yields to December levels shows sentiment turns still pack a punch, the European earnings season has been mixed so far, there are political murmurs about capping the euro and the political calendar over the next six weeks is a bit of a minefield for nervy markets. All the issues still look resolvable – the tricky Irish bank debt rejig looks on the verge of a resolution; few still believe Berlusconi be the next Italian PM (only 5 percent on betting website Intrade think so, for example); and Cyprus is expected by most to get bailed out eventually. Today’s ECB will be critical to most of those issues, but next week’s euro group gets a chance to update everyone on its role in them aswell). The issue likely to gnaw deepest at investors is the regional growth outlook  and,  in that respect, the euro surge is about as welcome as a kick in the teeth at this juncture. (Euro Q4 GDPs out next week). The French clearly want to rein in the currency but don’t have the tools or the German backing. Draghi and the ECB will likely have to come to rescue again, though he will not admit to euro targeting and so may drag his feet on this one until the move starts to burn. Interesting times ahead and interesting G20 finance meeting in Moscow next week as a result.

To keep this week’s market wobble  in Europe in perspective, however Wall St still continues to hover close to record highs as the Q4 GDP shock was probably correctly dismissed as a red herring; Japan’s TOPIX is now up 35% in three months (well, about 15% in euro terms), and Shanghai is up 18% in just two months. It’s curious to note that Shanghai was the top pick of the year when Reuters polled global forecasters in December and average gains for the whole of 2013 were expected to be… 17 percent. So, stick with the growth and the currency printing regions for now it seems – even if you do get whacked on the exchange rate.