This Week's Emerging Markets Highlights

Given that the weak China Q1 GDP report has led to renewed concerns about growth there, the HSBC flash PMI reading that comes out this Saturday has taken on greater importance. HSBC measure rose to 51.6 in March from 50.4 in February, but the official PMI rose to only 50.9 from 50.1 in February. This will be the first economic reading for Q2. The deceleration in the economy in Q1 was very disappointing, and we note that Q2 has an extra wild card thrown in due to avian flu risks. The US Treasury on Friday declined to name China a currency manipulator, and came as USD/CNY was making new lows for the cycle. With growth concerns likely rising and the currencies of China’s trade competitors weakening, we think the yuan could see some near-term weakness.

Turkey’s central bank meets Tuesday and is expected to cut the 1-week repo rate 25 bp to 5.25%. The rates corridor is expected to be adjusted downward by 25-50 bp. The bank is in a tough situation, as inflation remains higher than desired at 7.3% y/y in March even as growth remains disappointing. To add more fuel to the fire, the external accounts have started to widen again, and will widen even further when growth finally picks up. The current account deficit is largely being finance by hot money, making this more problematic going forward. But for now, it appears that the focus remains on boosting growth and limiting lira strength. With the REER measure moving above the 120 level that has triggered concern before, we think the potential easing this week would also be meant to address currency gains. The central bank kept its dovish stance intact last month with a 100 bp cut to overnight lending rate, which is the top end of the rates corridor.

Brazil central bank meets Wednesday and consensus view is to keep rates steady at 7.25%. However, the market is split and this will be one of the tougher calls this week as the Brazilian authorities continue to send many conflicting signals to the market. Bloomberg survey shows 20 calling for no change, 9 calling for a 25 bp hike, and 5 calling for a 50 bp cut. However, most of the responses were made before Friday’s comments. After previously looking for no move this week, our base case is now leaning towards a hike given rising risks of a hawkish surprise after official comments last week that seem to presage the start of the tightening cycle. Central bank chief Tombini on Friday used stronger language than usual when he said he would “monitor closely” economic indicators in setting monetary policy. Finance Minister Mantega joined in as well, saying Friday that policymakers will take unpopular measures to fight inflation, if needed. It is a tossup, but if COPOM stands pat this week, then a hike in May is virtually a certainty.

South Africa March CPI will be reported Wednesday, expected at 6.0% y/y vs. 5.9% y/y in February. South Africa rounds out the big three in EM in terms of stagflationary impulses, with retail sales for February reported that same day likely to show very weak consumption. Here too, the economy is still slowing but inflation remains at the top of the SARB’s 3-6% target range. SARB next meets May 23, and we think that may be too soon to see any easing. However, if the economy remains sluggish in Q2, we think easing could resume in H2, possibly at the meeting after that on July 18. The current account deficit remains an issue, and (like Turkey) is financed largely by hot money. At least Brazil for now has the luxury of having FDI cover the current account gap. The plunge in gold prices is also likely to weigh on the rand as well. The economy has already been hurt by a drop in volume, but a 10% drop in prices over the past two days spells more trouble ahead.

Colombia is expected to announce a stimulus package of some sort on Monday, and is expected to contain measures to weaken the peso. Officials have downplayed Brazil-type capital controls as a response, and so we are left with the more mundane possibilities along the lines of greater FX intervention. Markets ended last week wary of potential measures, taking USD/COP up to near recent highs around 1840. Finance Minister Cardenas estimated that the peso is about 10% overvalued.

Colombia is just one of many in EM that are concerned about currency strength. Israel intervened last Monday, while Chile and Turkey are also starting to jawbone a bit more. And we think Brazil will intervene if USD/BRL breaks below 1.95.

The plunge in gold is hogging much of the market’s attention, but we note that copper and oil are also succumbing to a generalized rout in commodities. Copper prices are down almost 3% today after a nearly 2.5% drop on Friday, while WTI oil is down over 5% over the past three days. This has hurt CLP and RUB, amongst others in EM FX. If the current bout of risk off trading persists, then concerns about currency strength will be put on the back burner.