Global Investing

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.

Accordingly swaps markets and analysts polls alike are penciling in more rate rises — the Selic rate is seen rising 75 bps by end-2013 to 8 percent. Second,  foreigners are betting on more real strength. The currency has broken 1.95 per dollar, a level that has previously triggered intervention (after spending a year hobbled in the 2.0-2.10 range) and the next level to watch for may be 1.9357, last hit in May 2009.

Bernd Berg, head of emerging currency strategy at Credit Suisse, reckons markets will keep testing the central bank’s tolerance for currency appreciation and the bank could respond with some intervention should the currency appreciate too fast. But it is not too-far fetched to expect the real to trade at 1.90 per dollar later this year, he says.

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.

When will Brazil’s central bank admit it has an inflation problem? Markets will be watching today’s rate-setting meeting for clues.

There is no doubt about the outcome of today’s meeting at the Banco Central do Brasil (BCB) — no one expects it to do anything but leave interest rates steady at the current 7.25 percent. But the BCB has been focused on growth for 18 months and has cut interest rates by 525 basis points in this time, its actions helping to drive the real 10 percent lower last year versus the dollar. The government meanwhile has unleashed huge doses of fiscal stimulus. The result, rather than a growth recovery, is a steady rise in inflation.

Goldman Sachs’ Latin America economist Alberto Ramos points out that Brazilian inflation came in above the 4.5 percent target for the third straight year in 2012 and the balance of inflation risks has deteriorated. Gasoline prices are to rise from next week and drought is making hydro-power generation more costly. Analysts polled by Reuters expect 2013 price growth at 5.53 percent. Ramos writes:

With Shinzo Abe’s new government intent on prodding the Bank of Japan into unlimited monetary easing, it is hardly surprising that the yen has slumped to two-year lows against the dollar. This could lead to even more flows into overseas markets from Japanese investors seeking higher-yield homes for their money.

Japanese mom-and-pop investors — known collectively as Mrs Watanabe -  have for years been canny players of currency and interest rate arbitrage. In recent years they have stepped away from old favourites, New Zealand and Australia, in favour of emerging markets such as Brazil, South Africa and Turkey. (See here  to read Global Investing’s take on Mrs Watanabe’s foray into Turkey). Flows from Japan stalled somewhat in the wake of the 2010 earthquake but EM-dedicated Japanese investment trusts, known as toshin, remain a mighty force, with estimated assets of over $64 billion.  Analysts at JP Morgan noted back in October that with the U.S. Fed’s QE3 in full swing, more Japanese cash had started to flow out.

That trickle shows signs of  becoming a flood. Nikko Asset Management, the country’s third  biggest money manager, said this week that retail investors had poured $2.3 billion into a mutual fund that invests in overseas shares — the biggest  subscription since October 2006. This fund’s model portfolio has a 64 percent weighting to U.S. shares, 14 percent to Mexico and 10 percent to Canada while the rest is split between Latin American countries.

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.

This year has been all about interest rate cuts. As Western central banks took their policy-easing efforts to ever new levels, emerging markets had little recourse but to cut rates as well. Interest rates in many countries from Brazil to the Czech Republic are at record lows.

Some countries such as Poland and Hungary are expected to continue lowering rates. Rate cuts may also come in India if a reluctant central bank finds its hand forced by the slumping economy. But in many markets, interest rate swaps are now pricing rate rises in 2013.

Are they correct in doing so? Emerging central banks will raise interest rates by an average 8 basis points next year, JP Morgan analysts predict.  UBS, in a recent note, reckons more EM central banks will raise rates than cut them. Analysts there offer the following graphic detailing their expectations:

A mixed bag this week on emerging policy and one that shows the growing divergence between dovish central Europe and an increasingly hawkish (with some exceptions) Latin America.

Hungary cut rates this week by 25 basis points, a move that Morgan Stanley described as striking “while the iron is hot”, or cutting interest rates while investor appetite is still strong for emerging markets. The current backdrop is keeping the cash flowing even into riskier emerging markets of which Hungary is undeniably one. (On that theme, Budapest also on Wednesday announced plans for a Eurobond to take advantage of the strong appetite for high-risk assets, but that’s another story).

So despite 6 percent inflation, most analysts had predicted the rate cut to 6 percent. With the central bank board  dominated by government appointees, the  stage is now set for more easing as long as investors remain in a good mood.  Rates have already fallen 100 basis points during the current cycle and interest rate swaps are pricing another 100 basis points in the first half of 2013. Morgan Stanley analysts write:

The past 24 hours have brought news of more fund launches targeting emerging corporate debt;  Barings and HSBC have started a fund each while ING Investment Management said its fund launched late last year had crossed $100 million.  We have written about the seemingly insatiable demand  for corporate emerging bonds in recent months,  with the asset class last month surpassing the $1 trillion mark.  Data from Thomson Reuters shows today that a record $263 billion worth of EM corporate debt has already been underwritten this year by banks, more than a fifth higher than was issued in the same 2011 period (see graphic):

The biggest surge has come from Latin America, the data shows, with Brazilian companies accounting for one-fifth of the issuance. A $7 billion bond from Brazil’s state oil firm Petrobras was the second biggest global emerging market bond ever.

The top 10 EM corporate bonds of the year:  Petrobras issued the two biggest bonds of $7 billion and $3 billion, followed by Venezuela’s PDVSA and Indonesia’s Petramina. Brazil’s Santander Leasing was in fifth place, Mexican firms PEMEX and America Movil were sixth and seventh.  Chilean miner CODELCO, Brazil’s Banco do Brasil and  Russia’s Sberbank also entered the list.

Emerging market central banks have clearly taken to heart the recent IMF warning that there is “an alarmingly high risk”  of a deeper global growth slump.

Two central banks have cut interest rates in the past 24 hours: Brazil  extended its year-long policy easing campaign with a quarter point cut to bring interest rates to a record low 7.25 percent and the Bank of Korea (BoK) also delivered a 25 basis point cut to 2.75 percent.  All eyes now are on Singapore which is expected to ease monetary policy on Friday while Turkey could do so next week and a Polish rate cut is looking a foregone conclusion for November.

South Africa, Hungary, Colombia, China and Turkey have eased policy in recent months while India has cut bank reserve ratios to spur lending.

With the U.S. Fed having cranked up its printing presses, there seems little to stop emerging central banks from extending their own rate cut campaigns this week.

The most interesting meeting promises to be in the Czech Republic. We saw some extraordinary verbal intervention last week from Governor Miroslav Singer, implying not only a rate cut but also recourse to “unconventional” monetary loosening tools. Of the 21 analysts polled by Reuters, 18 are expecting a rate cut on Thursday to a record low 0.25 percent.  Indeed, in a world of currency wars, a rate cut could be just what the recession-mired Czech economy needs. But Singer’s deputy, Moimir Hampl,  has muddled the waters by refuting the need for any unusual policies or even rate cuts.  Expect a heated debate (forward markets are siding with Singer and pricing a rate cut).

Hungary is a closer call, with 16 out of 21 analysts in a Reuters poll predicting an on-hold decision. The central bank board (MPC) is split too. Analysts at investment bank SEB point out that last month’s somewhat surprising rate cut was down to the four central bank board members appointed by the government. These four outvoted Governor Andras Simor and his two deputies who had favoured holding rates steady, given rising inflation. (Inflation is running at 6 percent, double the target).  That could happen again, given the government just last week reiterated the need for “lower interest rates and ample credit.  So SEB analysts write: