Global Investing

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.

The big question is how will investors react?

A test will come on Tuesday, when the government will try to raise $724 million via an auction of domestic bonds and T-bills.  There has been some flight by bond investors in recent days  but most have stayed put – after all they are earning a 5-6 percent carry on bonds and currency exposure can be hedged.  Above all, people are betting the central bank is capable of stemming any big falls in the currency.  (They are probably right: Deputy Governor Hartadi  Sarwono assured investors last week that if the rupiah weakened too much, the bank would “definitely respond to it via interest rate policy”).  UBS strategist Manik Narain points out the central bank has $112 billion in its coffers while interest rates are at a record low 5.75 percent:

The central bank has a considerable arsenal. They haven’t even started to raise rates yet and if we were to see some monetary tightening, investors will quickly pay attention and come back.  They can also deploy some of their considerable reserves.

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.

Asia’s ballooning debt

Could Asia be headed for a debt crisis?

The very thought may seem ludicrous given the region’s mighty current account surpluses and brimming central bank coffers.  But a note from RBS analysts Drew Brick and Rob Ryan raises some interesting concerns.

Historically speaking, most EM crises have been borne on the back of excessive capital inflows, Brick and Ryan write. And in many Asian countries, the consequence of these flows has been over-easy monetary policy that has left citizens and companies addicted to cheap money. Personal and corporate indebtedness levels have spiralled even higher in the past five years as governments across the continent responded to the 2008 credit crunch by unleashing billions of dollars in stimulus.

First, some numbers and graphics:

a) Asia’s current account surplus stands now around $250 billion, less than half its 2007 peak as exports have slumped.

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.

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:

Moody’s takes some pressure off Turkey

Moody’s disappointed a lot of folks this week when it failed to raise Turkey’s credit rating to investment grade.

After Fitch upped Turkey on Nov 5 into the coveted top tier, hopes were high that Moody’s would do the same and soon. Being rated investment grade by at least two agencies has a lot of pluses .  But all the subsequent investment inflows have side effects and one of them is currency appreciation.  Check out these graphs. (click to enlarge)

The currency has been a headache for Turkey’s central bank for a while now. Back in 2010, lira appreciation was the motivation for embarking on an unorthodox monetary policy.  This year in nominal terms the lira has gained just over 5 percent against the dollar, as Turkish stocks and bonds, among the best performers in the world in 2012, have lured foreigners.