Global Investing

Emerging policy-One cut, two steady

What a varied bunch emerging markets have become. At last week’s monetary policy meetings, we saw one rate rise (Serbia) and differing messages from the rest. Mexico turned dovish while hitherto dovish Brazilian central bank finally mentioned the inflation problem. Russia meanwhile kept markets guessing, signalling it could either raise rates next month or cut them.

This week, a cut looks likely in Turkey while South Africa and the Philippines will almost certainly keep interest rates steady.

Turkey’s main policy rate – the one-week repo rate – and overnight lending rate are widely expected to stay on hold at 5.50 percent and 9 percent respectively on Tuesday. But some predict a cut in the overnight borrowing rate – the lower end of the interest rate corridor, motivated partly by the need to keep the currency in check.   The lira is trading near 10-month highs, thanks to buoyant inflows to Turkish capital markets.  That has helped lower inflation from last year’s double-digit levels.

Goldman Sachs in fact, reckon the central bank will cut both the borrowing and lending rates by 25bps and also raise the Reserve Option Coefficient (the amount of foreign currency that lenders have to provide for the gold portion of their central bank reserves). They write:

We believe that the Bank has shifted focus towards the financial stability risks posed by accelerating capital inflows, and away from domestic inflation. We believe a combination of ROC hikes and (more visibly) cuts to the borrowing and lending rates, bringing the interest rate corridor down, will be used to lean against these inflows and their subsequent FX appreciation pressures.

The Watanabes are coming

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.

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.

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.

EM interest rates in 2013 – rise or fall

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:

Emerging policy-Down in Hungary; steady in Latin America

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:

Emerging Policy-Data vindicates doves but not all are cutting

Rate decisions last week in emerging markets well anticipated this week’s crop of economic data.

Russia for instance not only kept rates on hold last Friday (after raising them at its previous meeting) but struck a less hawkish tone than expected. Voila, data this week showed growth in the third quarter was 2.9 percent compared to 4 percent in April-June.

We’ll have to wait for November 30 to see what Poland’s Q3 growth numbers look like but data today shows inflation eased to two-year lows in October. That appears to vindicate the central bank’s decision to cut interest rates last week. for the first time in three years.  Simon Quijano-Evans at ING Bank writes: