Global Investing

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:

Based on our economists’ view of a 25bp repo rate cut in Q1, and a further 50bp in Q2, we expect the bond curve to fall around 55bp in a parallel move. As such, we recommend extending duration to long end bonds….Given high carry, attractive price returns and our forecast for modest nominal appreciation of the  rupee, we expect an approximately10% dollar return (FX unhedged), and a 7% return (FX hedged) on 30-year bonds in the next six months.

But what could eventually determine the extent of policy easing is the upcoming 2013-2014 budget.

No Czech intervention but watch the crown

The Czech central bank surprised many this week after its policy meeting. Widely expected to announce the timing and extent of FX market interventions, Governor Miroslav Singer not only failed to do so, he effectively signalled that intervention was no longer on the cards — at least in the short term  In his words, looser monetary conditions were now “less urgent”.

What changed Singer’s mind? After all, data just hours earlier showed Czech industrial production plunging  12 percent year-on-year in December. The economy has not grown since mid-2011 and is likely to have contracted by more than 1 percent last year. Singer in fact predicts a second full year of recession. But some slightly upbeat-looking forward indicators could be cause for cheer. According to William Jackson at Capital Economics:

We think that the need for further policy loosening was tempered by the tentative pick-up in the most recent survey data as well as the fall in the crown (versus the euro) since the start of the year.

Indian markets and the promise of reform

What a difference a few months have made for Indian markets.

The rupee is 8 percent up from last summer’s record lows. Foreigners have ploughed $17 billion into Indian stocks and bonds since Sept 2012 and foreign ownership of Indian shares is at a record high 22.7 percent, Morgan Stanley reckons.  And all it has taken to change the mood has been the announcement of a few reforms (allowing foreign direct investment into retail, some fuel and rail price hikes and raising FDI limits in some sectors). A controversial double taxation law has been pushed back.  The government has sold some stakes in state-run companies (it offloaded 10 percent of Oil India last week, netting $585 million).  If the measures continue, the central bank may cut interest rates further.

Above all, there have been promises-a-plenty on fiscal consolidation.

The promises are not new. Only this time, investors appear to believe Finance Minister P. Chidambaram.

Chidambaram who was on a four-city roadshow to promote India to investors, pledged in a Reuters interview last week not to cross the “red line” of a 5.3 percent deficit for this year in the Feb 28 budget. Standard Chartered, one of the banks that organised Chidambaram’s roadshow, sent out a note entitled: “The finance minister means business”.

Emerging Policy-Doves reign

Rate cuts are still coming thick and fast in emerging markets — in some cases because of falling inflation and in others to deter the gush of speculative international capital.

Arguably the biggest event in emerging markets is tomorrow’s Reserve Bank of India (RBI) meeting which is expected to yield an interest rate cut for the first time in nine months.

India’s inflation, while still sticky, eased last month to a three-year low of around 7 percent. And a quarter point rate cut to 7.75 percent will in effect be a nod from the RBI to the government’s recent reform efforts.  In anticipation of a rate cut, Indian 10-year bond yields have dropped 50 basis points since the start of the year.  But the RBI, probably the world’s most hawkish central bank at present, has warned that markets need not expect a 50 bps cut or even a sustained rate-cutting campaign. Governor Duvvuri Subbarao said last week inflation still remains too high for comfort, while on Monday the RBI said in a quarterly report that more reform was needed to make the central bank turn its focus on growth.

Hyundai hits a roadbump

The issue of the falling yen is focusing many minds these days, nowhere more than in South Korea where exporters of goods such as cars and electronics often compete closely with their Japanese counterparts. These companies got a powerful reminder today of the danger in which they stand — quarterly profits from Hyundai fell sharply in the last quarter of 2012.  (See here to read what we wrote about this topic last week)

Korea’s won currency has been strong against the dollar too, gaining 8 percent to the greenback last year. In the meantime the yen fell 16 percent against the dollar in 2012 and is expected to weaken further. Analysts at Morgan Stanley pointed out in a recent note that since June 2012, Korean stocks have underperformed Japan, corresponding to the yen’s 22 percent depreciation in this period. Their graphic below shows that the biggest underperformers were consumer discretionary stocks (a category which includes auto and electronics manufacturers). Incidentally, Hyundai along with Samsung, makes up a fifth of the Seoul market’s capitalisation.

Shares in Hyundai and its Korean peer Kia have fared worst among major global automakers for the past three months – down 5 percent and 18 percent, respectively.  Both companies expect sales this year to be the slowest in a decade. Toyota on the other hand has risen 30 percent and expects to reach the top spot in terms of world sales for the first time since 2010.

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.

Korean exporters’ yen nightmare (corrected)

(corrects name of hedge fund in para 3 to Symphony Financial Partners)

Any doubt about the importance of a weaker yen in thawing the frozen Japanese economy will have been dispelled by the Nikkei’s surge to 32-month highs this week. Since early December, when it became clear an incoming Shinzo Abe administration would do its best to weaken the yen, the equity index has surged as the yen has fallen.

Those moves are giving sleepless nights to Japan’s neighbours who are watching their own currencies appreciate versus the yen. South Korean companies, in particular, from auto to electronics manufacturers, must be especially worried. They had a fine time in recent years  as the yen’s strength since 2008 allowed them to gain market share overseas. But since mid-2012, the won has appreciated 22 percent versus the yen.  In this period, MSCI Korea has lagged the performance of MSCI Japan by 20 percent. Check out the following graphic from my colleague Vincent Flasseur (@ReutersFlasseur)

David Baran, co-founder of Tokyo-based Symphony Financial Partners, notes the relative performance of Hyundai and Toyota (Hyundai shares have fallen 2.5 percent this year adding to 13.5 percent loss in the last quarter of 2012. Toyota on the other hand is up 5 percent so far in 2013 after gaining 31 percent in Oct-Dec last year). Baran says he has gone long the Nikkei and short the Seoul index (the Kospi) and (Hong Kong’s) Hang Seng, while taking a short position on the yen. He says:

Brazil’s inflation problem

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:

Rupiah decline – don’t worry

Indonesia has just given the go-ahead for another leg down in the rupiah. It has cut its forecasts for the exchange rate to 9,700 per dollar compared to the 9,200 level at which the central bank used to step in. The currency has duly weakened and nervous foreigners have rushed to hedge exposure — 3-month NDFs price the rupiah at almost 10,000 to the dollar. The  rupiah last week hit a three-year low, its weakness coming on top of a dismal 2012 which saw it fall 6 percent as the current account deficit worsened. Traders in Jakarta are reporting dollar hoarding by exporters.

All that is spooking foreigners who own more than 30 percent of the domestic bond market. The currency weakness hit them hard last year as Indonesian bonds returned just 6 percent, a third of the sector’s 16 percent average (see graphic).

The central bank does not seem perturbed by the currency weakness. Luckily for it, inflation rates are still benign, which means a weak currency will probably remain in favour.

Emerging debt vs equity: to rotate or not

Emerging bonds have got off to a flying start in 2013, with debt funds taking in over $2 billion this past week, the second highest weekly inflow ever, according to fund tracker EPFR Global. Issuance is strong -  Turkey for instance this week borrowed cash repayable in 10 years for just 3.47 percent, its lowest yield ever in the dollar market.

Yet not everyone is optimistic and most analysts see last year’s returns of 16-18 percent EM debt returns as out of reach. The consensus instead seems to be for 5-8 percent as  tight spreads and low yields leave little room for further ralliesaverage yields on the EMBI Global sovereign debt index is just 4.4 percent.    Domestic bonds meanwhile could suffer if inflation turns problematic. (see here for our story on emerging bond sales and returns).

Now take a look at U.S. Treasury yields which are near 8-month highs. and could pose a headwind for emerging debt. Higher U.S. yields are not necessarily a bad thing for emerging markets provided the rise is down to a healthier economic outlook.  But that scenario could induce investors to turn their attention to equities and  indeed this is already happening. EPFR data shows emerging equity funds outstripped their bond counterparts last week, taking in $7.45 billion, the highest ever weekly inflow.