Global Investing

Amid yen weakness, some Asian winners

Asian equity markets tend to be casualties of weak yen. That has generally been the case this time too, especially for South Korea.

Data from our cousins at Lipper offers some evidence to ponder, with net outflows from Korean equity funds at close to $700 million in the first three months of the year. That’s the equivalent of about 4 percent of the total assets held by those funds. The picture was more stark for Taiwan funds, for whom a similar net outflow equated to almost 10 percent of total AuM. Look more broadly though and the picture blurs; Asia ex-Japan equity funds have seen net inflows of more than $3 billion in the first three months of the year, according to Lipper data.

Analysts polled by Reuters see more drops ahead for the yen which they predict will trade around 102 per dollar by year-end (it was at 77.4 last September). Some banks such as Societe Generale expect a 110 exchange rate and therefore recommend being short on Chinese, Korean and Taiwanese equities.

But the weak yen may not be unilaterally bad news for Asian companies. Morgan Stanley analysts have compiled a list of Asian shares that could gain from falling yen costs. Take India’s Maruti-Suzuki. It has zero exposure to yen in terms of revenue but its cost exposure (due to import or components) is 34 percent. A similar picture at China Motor Corp. in Taiwan. Another Taiwanese firm, semiconductor maker Siliconware Precision has a 2 percent revenue exposure to Japan but the yen accounts for 15 percent of its cost base, according to MS data.

Other examples.  MS highlights Taiwan’s casings maker Catcher which holds 54 percent of its debt in yen. It calculates that every 1 percent fall in the yen translates to 1.3 percent upside to its annual income. Tour operators and airlines could also benefit if they are able to send more visitors to newly-cheap Japan.

Less yen for carry this time

The Bank of Japan unleashed its full firepower this week, pushing the yen to 3-1/2 year lows of 97 per dollar.  Year-to-date, the currency is down 11 percent to the dollar. But those hoping for a return to the carry trade boom of yesteryear may wait in vain.

The weaker yen of pre-crisis years was a strong plus for emerging assets, especially for high-yield currencies. Japanese savers chased rising overseas currencies by buying high-yield foreign bonds and as foreigners sold used cheap yen funding for interest rate carry trades. But there’s been little sign of a repeat of that behaviour as the yen has fallen sharply again recently .

Most emerging currencies are flatlining this year and some such as the Korean won and Taiwan dollar are deep in the red. The first reason is dollar strength of course, but there are other issues. Take equities — clearly some cash at the margins is rotating out to Japan, where equity mutual funds have received $14 billion over the past 16 weeks.  While the Nikkei is up 21 percent, Asian indices are broadly flat. In South Korea whose auto firms such as Hyundai and Kia compete with Japan’s Toyota and Honda, shares are bleeding foreign cash. The exodus has helped push the won down 5 percent to the dollar in 2013.

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.

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.

Using sterling to buy emerging markets

Sterling looks likely to be one of this year’s big G10 currency casualties (the other being  yen).  Having lost 7 percent against the dollar and 5.5 percent to the euro so far this year on fear of a British triple-dip recession, sterling probably has further to fall.  (see here for my colleague Anirban Nag’s take on sterling’s outlook).

Many see an opportunity here — as a convenient funding currency to invest in emerging markets. A funding currency requires low interest rates that can bankroll purchases of higher-yielding assets including stocks, other currencies, bonds and commodities. Sterling ticks those boxes.  A funding  currency must also not be subject to any appreciation risk for the duration of the trade. And here too, sterling appears to win, as the Bank of England’s remit widens to give it more leeway on monetary easing.

All in all, it’s a better option than the U.S. dollar, which was most used in recent years, or the pre-crisis favourite of the Swiss franc, says Bernd Berg, head of emerging FX strategy at Credit Suisse Private Bank.

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.

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.