Emerging Markets: What Has Changed

In the EM equity space, Korea (-3.3%), Brazil (-3.0%), Taiwan (-3.0%) have outperformed over the last week, while China (-7.8%), Israel (-5.8%), and India (-3.6%) have underperformed.

In the EM local currency bond space, longer-dated yields in Russia (-45 bp), Turkey (-24 bp) and Indonesia (-23 bp) have outperformed over the last week, while Colombia (+21bp), Peru (+13bp) and South Korea (+9bp) have underperformed. To put this in better context, the 10-Year UST yield rose 4 bp over the past week.

In the EM FX space, RUB (+2.9%), KRW (+1.8%) and TWD (+1.3%), have outperformed over the last week, while ZAR (-2.3%), BRL (-1.8%), and COP (-1.7%) have underperformed.

1) Turkey has formed an interim government, but the AKP is slipping in the polls. The ruling AKP has invited one MP from the nationalist party MHP and three from the Kurdish HDP. The cabinet is still to be announced. The other opposition party CHP did not accept the five MP positions, so they will be filled by “independent” appointments. New elections will be held on November 1. Meanwhile, the latest poll showed that AKP would win only 240 deputies in parliament, down from 258 in the last elections. The biggest gaining party would be the CHP, with its support increasing 28%, but the MPH and the CHP would also see solid gains.

2) The South Africa Reserve Bank (SARB) is debating FX intervention, but sending confused messages. The SARB released a statement this week saying that it could get involved in FX markets. The idea is to protect the country from “developments that threaten the orderly functioning of markets” and financial stability. This didn’t have any immediate impact on ZAR, nor would we have expected it to. After all, this is a commitment to a future action, and conditional on premises that are not well defined. The curious part is that, in an interview two days later, SARB’s governor Kganyago sounded decidedly less enthusiastic about FX intervention. He talked about the prospects of getting involved in the FX market by using its “power of persuasion” to ensure that liquidity conditions remain ample. We are not sure what he has in mind here.

3) Korea steps up its rhetoric to contain market volatility and announces new stimulus measures. Korean Finance Minister vowed to “actively” respond to financial market concerns, but didn’t cite any specific measures. Still, this moves both countries further down the spectrum of the more active central banks in the EM space. Separately, the government decided to cut the consumption tax by 30% on several goods, including cars, home appliances and heal supplements.

4) The Bank of Israel has renewed talk of unconventional measures. Governor Flug said the central bank could cut interest rates below zero if circumstances warrant. This is a change from previous comments that downplayed the risk of negative rates. The central bank just left rates at 0.1% on Monday, but warned that risks to the economy and prices have increased. We think the comments were likely meant as push-back to recent shekel gains. ILS has outperformed within EM, nearly flat on the year vs. USD even as the worst performers are down -25% YTD.

5) Ukraine and its creditors have reached an agreement on debt restructuring. The deal will reportedly include a 20% writedown on principal as well as maturity extensions, as existing bonds are all rolled into nine new bonds, all paying 7.75%. The new bonds will also contain GDP warrants that reward bondholders if the country experiences stronger growth. Ukraine said it is offering the same terms to Russia, but Finance Minister Siluanov stated that Russia would not participate in the restructuring and that it expects payment in full on its $3 bln bond coming due in December. We think the 20% haircut was very generous for the creditors, as past restructurings in other countries have seen haircuts in the 30-40% range.

6) The source of tension in Brazilian politics is shifting. The risk of an imminent impeachment process has declined substantially, in our view. On the other hand, the most important member of the government coalition, the PMDB, is threatening to split from the ruling PT. In particular, Vice President Temer is set to leave his post as political coordinator. This only compounds the growing concerns of fiscal slippage relative the initial ambitious plans of Finance Minister Levy. Not even the positive news that President Dilma would conduct a political reform to cut the number of ministers was enough to improve the political mood.

7) There were several new measures out of China this week. Regulators allowed pension funds to hold as much as 30% in stocks for the first time. Beijing also stepped up its enforcement of a ban on selling by large shareholders. A statement by the Ministry of Commerce said the government would lower the threshold for foreign capital to participate in the domestic property markets. And the Ministry of Finance decided to further expand the local government swap program to RMB3.2 tln from RMB2.0 tln. In addition to all this, there has been a lot of speculation about official support for the equity markets.

8) Mexican President Nieto and his finance minister were cleared of some of the corruption allegations. A government auditor exonerated the president from its conflict of interest allegations relating to the purchase of his home from public contractors. We very much doubt this will be the end of the story, especially with public opinion still turning against him.

By my colleague Ilan Solot