Global Investing

Taiwan’s forecast-beating export data today came as a pleasant surprise amid the general emerging markets economic gloom.  In a raft of developing countries, from South Korea to Brazil, from Malaysia to the Czech Republic, export data has disappointed. HSBC’s monthly PMI index showed this month that recovery remains subdued.

With Europe still in the doldrums, this is not totally unsurprising. But economists are growing increasingly concerned because the lack of export growth coindides with a nascent U.S. recovery. Clearly EM is failing to ride the US coattails.

Does all this confirm the gloomy prediction made last month by Morgan Stanley’s chief emerging markets economist, Manoj Pradhan. Pradhan reckons that a U.S. economy in recovery would be a competitor rather than a client for emerging markets, as  the world’s biggest economy tries to reinvent itself as a manufacturing power and shifts away from consumption-led growth. It is the latter that helped underwrite the export-led emerging market boom of the past decade.

It’s early days yet. Yet the impact of the U.S. rebound this time does appear different from the past.

Typically, a recovery in the United States leads to a rise in demand for all sorts of products – chemicals,  home furnishing, clothing, footwear, light manufacturing,  electrical appliances, machinery and equipment, transport – and this leads to a broad-based rebound in imports, analysts at UBS say. That has not happened in this cycle, and imports from  EM in particular have lagged. The answer, according to UBS, lies in the kind of things the United States has been importing. Look at their chart below  - most in demand are heavy machinery and transport equipment because the rebound is centred on construction, autos and infrastructure. UBS says:

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.

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.

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”.

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 market currencies have been a source of frustration for investors this year. With central banks overwhelmingly in rate-cutting mode and export growth slowing, most currencies have performed poorly. That has been a bit of a dampener for local currency debt –  while returns in dollar terms have been robust at 13 percent, currency appreciation has contributed just 1.5 percent of that, according to JP Morgan.

The picture could be changing though.  Fund managers at the Reuters 2013 investment outlook summit this week have been unanimously bullish on emerging debt, with many stating a preference for domestic debt. So far this year, dollar debt has taken in three-quarters of all inflows to emerging fixed income.

Andreas Uterman, CIO of Allianz Global Investors told the summit in London that many emerging currencies looked significantly undervalued, and that this anomaly would gradually resolve itself:

Investors are wondering how much longer the rally in South Africa’s local bond markets will last.

The market has received inflows of over $7.5 billion year-to-date, having benefited hugely from Citi’s April announcement that it would include South Africa in its elite World Government Bond Index (WGBI).  But like many other emerging markets, South Africa has also gained from international investors’ hunger for higher-yielding bonds. And the central bank’s surprise rate cut last week was the icing on the cake, sending 5-year yields plunging another 30 basis points.

There are some headwinds however. First positioning. Around a third of government bonds are already estimated to be in foreigners’ hands. Second, markets may be pricing in too much policy easing (Forward rate agreements are assigning a 77  percent probability of another 50 bps rate cut within the next six months).  That’s especially so given local wheat and maize prices have been hitting record highs in recent weeks.

Is the National Bank of Poland (NBP) the last inflation-targeting central bank still standing?

The bank shocked many today with a quarter point rate rise, naming stubbornly high inflation as the reason, and signalling that more tightening is on its way. The NBP has sounded hawkish in recent weeks but few had actually expected it to carry through its threat to raise rates. Economic indicators of late have been far from cheerful – just hours after the rate rise, data showed Polish car production slumped 30 percent in April from year-ago levels. PMI numbers last week pointed to further deterioration ahead for manufacturing. And sitting as it does on the euro zone’s doorstep, Poland will be far more vulnerable than Brazil or Russia to any new setback in Greece. Its action therefore deserves praise, says Benoit Anne, head of emerging markets strategy at Societe Generale.

(Poland’s central bank) is one of the last orthodox inflation-targeting central banks in the global emerging market central bank universe. They are taking action because they are seeing inflation creeping up and have decided to be proactive.

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.

It’s the economy, stupid. Or isn’t it?

Brent crude has risen 15 percent since the end of last year, focusing people’s minds on the potential this has to choke off the recovery in world growth. But some reckon it is the recovery that’s at least partly responsible for the surging oil prices — economic data from United States and Germany has been strong of late. There are hopes that France and the United Kingdom may escape recession after all. And growth in the developing world has been robust.

Geopolitics of course is playing a role  as an increasing number of countries boycott Iranian oil and fret over a possible military strike by Israel on Iran’s nuclear installations.  But Deutsche Bank analysts point out that world equity markets, an efficient real-time gauge of growth sentiment, have risen along with oil prices.

Their graphic (below) shows a remarkably close relationship between oil prices and the S&P 500. Click to enlarge