What’s Changed In The Emerging Markets?

We do note that countries that tightened aggressively and preemptively last year are seeing their currencies hold up better than those that are late to the game. Indonesia, India, and Brazil are in the former group, while South Africa and Turkey are in the latter group.

While the Fed tapering has been blamed for much of the carnage in EM, we think the underperformance of many currencies are idiosyncratic, due largely to homegrown problems, both political and economic. This applies to Argentina, Thailand, Turkey, Ukraine, and others. Yet the (perceived) receding of global capital flows has perhaps exposed and magnified the cracks in EM fundamentals.

Even though no one in EM appears safe from the selling pressures, we are at least heartened by the divergence of performances within EM. We continue to believe that the repricing of EM assets still has a ways to go, and warn that FX markets are prone to overshooting. At some point, this will prove a good buying opportunity for the likes of MXN, PLN and KRW. But we are not there yet.

Price action: Over the last week, Egypt (+2.5%), Malaysia (-0.2%), and Korea (-0.3%) have outperformed in the EM equity space in local currency terms, while Chile (-6.5%), Peru (-6%), and Hungary (-4.3%) have underperformed. In the EM local currency bond space, Hong Kong (10-year yield down 10 bp), Chile (down 5 bp), and Korea (down 4 bp) have outperformed over the last week, while Hungary (10-year yield up 78 bp), Peru (up 56 bp), and South Africa (up 35 bp) have underperformed. In the EM FX space, TRY (+2% vs. USD), MXN (+1%) and CLP (+0.6%) have outperformed over the last week, while RUB (-2.3% vs. USD), ZAR (-1.5%), and ARS (-2%) have underperformed.

1) Colombia may slow or stop its dollar purchase interventions
2) The Turkish central bank hike was less than meets the eye, and so was the initial reaction in the lira
3) Russia moves its corridor aggressively again, but rate hikes are unlikely (for now)
4) The forint is getting punished as the dovish bias remains intact
5) The South African Reserve bank unexpectedly jumps on the tightening bandwagon.

1) Colombia may slow or stop its dollar purchase interventions. The stress in EM FX has even got to one of most aggressive proponents of a competitive currency. Finance Minister Cardenas cast doubt on the central bank’s recent commitment towards its intervention program – to buy as much as $1bln in the first three months of the year – by reinforcing that the amount was a “ceiling.” President Santos also reversed his position on the currency by stating that the intervention program was no longer necessary. Recall that just last month, the Minister described the strong peso as “the mother of all problems.” USD/COP has just crossed over the key psychological level of 2,000 for the first time since 2010. We suspect that policymakers are comfortable with the peso around these levels, but not much weaker than this.

2) The Turkish central bank hike was less than meets the eye, and so was the initial reaction in the lira. The large hike and simplification of its monetary policy system were both welcome developments, though it could be too little too late. When all was said and done, the effective tightening was 225 bp as the effective policy rate was moved to 10.0%. At least now real interest rates are decidedly in positive territory. But the bank still has a long way to go in order to build up credibility, and Turkey’s fundamental challenges (current account deficit, low reserves, political uncertainty) are not about to go away anytime soon. The lira traded in a 9.5% range from peak (2.39) to trough (2.16) this week, settling somewhere in the middle at 2.29 currently. Even Prime Minister Erdogan came to the defense of the lira, saying that the government might announced an alternative economic package if the recent tightening fails to stabilize financial markets.

3) Russia moves its corridor aggressively again, but rate hikes are unlikely (for now). Officials seem to be downplaying the significance of the recent currency devaluation, characterizing it as “temporary” and expected to be reversed soon. Recent comments also suggest that Russia will not be joining the club of EM rate hiking, while other comments suggest that a ruble free float may be delayed beyond the 2015 target. Today, the CBR shifted the ruble corridor by 20 kopecks to 33.95-40.95, this follows a 15 and a 5 corridor shift earlier in the week.

4) The forint is getting punished as the dovish bias remains intact. It’s important to note here that Hungary’s fundamentals are relatively strong compared to most EM countries under attack – notably, it’s current account surplus is running around 2% of GDP. Bucking the trend, the Hungarian government stated that it has "some" room to continue cutting interest rates. The central bank is sticking to its narrow inflation target which is still seen as "the only monetary policy anchor is medium-term,” according to recent comments. The forint has lost over 5% against the euro YTD, and further underperformance is likely ahead.

5) The South African Reserve bank unexpectedly jumps on the tightening bandwagon. Yet the rand has not really reacted positively to the move. Both M3 and credit have slowed to cycle lows in December even as PPI rose 6.5% y/y vs. 5.8% in November. There are further upside risks to inflation readings ahead due to the weak rand. The economy is facing slower growth as well as rising inflation in an election year, and rate hikes will only exacerbate this policy dilemma. Yet there is also an argument that negative real interest rates cannot be sustained at a time when the Fed is tapering and investor sentiment on EM is souring.

(from my colleagues Dr. Win Thin and Ilan Solot)