Emerging Markets: What Has Changed

1) The near-term outlook for EM has brightened a bit with the Fed’s about face on tapering

2) The BOK is thought to have intervened by BUYING USD at the 1080 level and below

3) New positive policy measures in India are seen, but more negative data makes Rajan’s life difficult

4) Pakistan surprised markets by starting a tightening cycle with a 50 bp hike to 9.5%

1) The near-term outlook for EM has brightened a bit with the Fed’s about face on tapering. While we view this as a short-term buying opportunity, we warn that the tapering decision has simply been pushed out a few months into the future. Given the emphasis the Fed put on the risks of higher US rates to the economic outlook, we think that the October 29/30 meeting is too soon to see any material change in the US outlook. That leaves the December 17/18 meeting, and will be very data dependent. We had been very negative for EM FX in Q4 due to tapering risks, but now think that QE may not be seen until early 2014 if US data continues to come in weak into end-2013. We remain very concerned that the Fed’s decision to delay tapering may simply make the eventual adjustment for EM FX that much more painful.

2) The BOK is thought to have intervened by BUYING USD at the 1080 level and below. This just goes to highlight the divergences of EM FX performances, as many others in EM have been SELLING dollars. Note, however, that we no longer attribute the performance of KRW solely to JPY. The correlation between JPY and KRW has declined substantially. For example, the 30-day rolling correlation between the two has turned negative in September to -0.18 now from a peak of around +0.50 in May. Still, recent moves have seen JPY/KRW pushed further below 11 towards a test of the May 22 low near 10.74. We do not think Korean policymakers will be happy with further won firmness, especially if USD/JPY manages to break above its recent trading ranges on the big change in the Fed outlook.

3) New positive policy measures in India are seen, but more negative data makes Rajan’s life difficult. The Exchange Board of India relaxed quotas for foreign institutional investors buying government debt – thus eliminating the requirement for them to buy debt quotas through monthly auctions. Still, Rajan is really in an unenviable position ahead of his first meeting at the helm of the RBI on Friday. August wholesale price inflation came in on the strong side at 6.10%, a six-month high. Not surprisingly, part of this was due to higher import prices from currency pass-through. Also, food prices spiked by 18.2% y/y after the monsoon damaged many crops, leading to a 77.8% y/y increase in vegetable prices. If recent INR gains are consolidated or even improved upon, then there may be scope for further RBI easing in the months ahead.

4) Pakistan surprised markets by starting a tightening cycle with a 50 bp hike to 9.5%. They are struggling with a weak rupee and rising inflation, and so further hikes are seen. CPI rose 8.3% y/y in July and 8.55% y/y in August and looks likely to continue accelerating. This 50 bp hike reverses the 50 bp cut done just in June, and marks the start of the first tightening cycle since 2010.