Global Investing

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 bank’s modus operandi seems to be to take rates down as long as the risk environment allows them.

The bank’s dovish stance has pushed short-end Hungarian yields more than 150 basis points lower since June while the forint has shrugged off the cuts to gain more than 11 percent this year against the euro. But not everyone is buying. Benoit Anne, head of EM strategy at Societe Generale advises clients to buy euro whenever the forint rises:             

Polish central bank governor Marek Belka doesn’t apportion a lot of importance to the fact that Poland can boast the second biggest improvement in the latest World Bank’s ease of doing business index, after Kosovo.

“This year we have improved, but I don’t care too much about it,”  Belka said at a meeting in London today.

Others do see a significant trend emerging from the data around Poland which paints an optimistic picture for those wishing to start and do business in Europe, but not necessarily in the developed markets.

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:

When Poland stunned markets in May with a quarter-point rate rise, analysts at Capital Economics predicted that the central bank would have an “ECB moment” before the year was over, a reference to the European Central Bank’s decision to cut interest rates last year, just months after it hiked them. A slew of weak economic data, from industrial output to retail sales and employment, indicates the ECB moment could arrive sooner than expected. PMI readings today shows the manufacturing business climate deteriorated for the fourth straight month, remaining in contraction territory.

With central banks all around intent on cutting rates, markets, unsurprisingly, are betting on easing in Poland as well. A 25 bps cut is priced for September and 75 bps for the next 12 months, encouraged by dovish comments from a couple of board members (one of whom had backed May’s decision to raise rates). Bond yields have fallen by 60-80 basis points.

Marcin Mrowiec, chief economist at Bank Pekao says:

The market should continue to expect that the (central bank) will unwind the rate hike delivered in May.

Just how miserable a month May was for global equity markets is summed up by index provider S&P which notes that every one of the 46 markets included in its world index (BMI)  fell last month, and of these 35 posted double-digit declines. Overall, the index slumped more than 9 percent.

With Greece’s anti-austerity May 6 election result responsible for much of the red ink, it was perhaps fitting that Athens was May’s worst performer, losing almost 30 percent (it’s down 65 percent so far this year).  With euro zone growth steadily deteriorating, even German stocks fell almost 15 percent in May while Portugal, Spain and Italy were the worst performing developed markets  (along with Finland).

The best of the bunch (at least in the developed world) was the United States which fell only 6.5 percent in May and is clinging to 2012 gains of around 5 percent. S&P analyst Howard Silverblatt writes:

The FOMC’s relatively anodyne conclusions left world markets with little new to chew on Thursday, with some poor European banking results for Q1 probably get more attention.  Broadly, world stocks were a touch higher while the dollar and US Treasury yields were slightly lower. European bank stocks fell 2% and dragged down European indices. Euro sovereign yields were slightly higher, with markets eyeing Friday’s Italian bond auction. Volatility gauges were a touch lower and crude oil prices nudged up.

Following is a selection of some of the day’s interesting research snippets:

- Deutsche Bank’s emerging markets strategists John Paul Smith and Mehmet Beceren said they retain their negative bias toward global emerging market equities both in absolute and relative terms, highlighting Argentina’s expropriation of YPF from Repsol as another negative. “We anticipate that so-called state capitalism will continue to be a negative driver, as it has been since mid-2010, since the poor economic backdrop makes the corporate sector a tempting target for governments wishing to boost their popularity or find additional resources to add to the relatively low levels of social protection across most emerging economies.” They added that they remain overweight “state lite” emerging markets such as Taiwan, Mexico and Turkey and underweight Russia, China, Brazil and South Korea.

The European Union has given Budapest the green light to seek aid from the IMF. (see here)  In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook  — to get its hands on the money, Viktor Orban’s government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank’s independence.  It remains to be seen if Orban will actually cave in.

But markets are reacting as if the IMF money is in Hungary’s pocket already. There have been sharp rallies in Hungarian dollar bonds,  CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely)  talking of issuing bonds on world markets.

What investors are hoping for now is a cut to the 7 percent interest rate. Hungary’s central bank jacked up rates by 100 bps in recent months to defend the forint as cash fled the country. Now there is a chance those rate rises can be reeled back in. After all, the moribund economy could really use a dash of monetary easing. Thanasis Petronikolos, head of emerging debt at Baring Asset Management has been overweight Hungary and  recalls that after 2008 crisis, the central bank was able to quickly take back its 300 bps of currency-defensive rate hikes.

More on Hungary. It’s not hard to find a Hungary bear but few are more bearish than William Jackson at Capital Economics.

Jackson argues in a note today that Hungary will ultimately opt to default on its  debt mountain as it has effectively exhausted all other mechanisms. Its economy has little prospect of  strong growth and most of its debt is in foreign currencies so cannot be inflated away. Austerity is the other way out but Hungary’s population has been reeling from spending cuts since 2007, he says, and is unlikely to put up with more.

How did other highly indebted countries cope? (lets leave out Greece for now). Jackson takes the example of  Indonesia and Thailand. Both countries opted for strict austerity after the 1997 Asian crisis and resolved the debt problem by running large current account surpluses. This worked because the Asian crisis was followed by a period of buoyant world growth, allowing these countries to boost exports. But Hungary’s key export markets are in the euro zone and are unlikely to recover anytime soon.

Hungary says it might borrow money from global bond markets before it lands a long-awaited aid deal with the International Monetary Fund. That pretty much seems to suggest Budapest has given up hope of getting the IMF cash any time soon. Given the fund has already said it won’t visit Hungary in April, that view would seem correct.

There is some logic to the plan.

Hungary desperately needs the cash — it must  find over 4 billion euros just to repay external debt this year.

It is also an attractive time to sell debt.  Appetite for emerging market debt remains strong. Emerging bond yield premiums over U.S. Treasuries have contracted sharply this year and stand near seven-month lows. Moreover, U.S. Treasury yields may rise, potentially making debt issuance more costly in coming months.

Nothing like an oil price spike to bring out the differences between the haves and have-nots of this world. The ones who have oil and those who don’t.

With oil at $124 a barrel,  the stock markets of big oil importers India and South Korea posted their first weekly loss of 2012 on Friday.  But in Russia, where energy stocks make up 60 percent of the index, shares had their best day since November, rising more than 4 percent. The rouble’s exchange rate with the dollar jumped 1.5 percent but the lira in neighbouring Turkey (an oil importer) fell.

Emerging currencies and shares have performed exceptionally well this year. Some of last year’s laggards such as the Indian rupee have risen almost 10 percent and stocks have jumped 16-18 percent. But unless crude prices moderate soon, the 2012 rally in the  stocks, bonds and currencies of oil-poor countries may have had its day. Societe Generale writes: