The Emerging FX Markets

Over the last week, Peru (+2.6%), Colombia (+2.3%), and Turkey (+2.0) have outperformed in the EM equity space in local currency terms, while Hong Kong (-1.9%), Korea (-1.8%), and Taiwan (-1.7%) have underperformed.

In the EM local currency bond space, Turkey (10-year yield -51 bp), Hungary (-14 bp), and Vietnam (-10 bp) have outperformed over the last week, while Ukraine (10-year yield +30 bp), Russia (+17 bp), and Thailand (+7 bp) have underperformed. To put this in better context, the 10-year UST yield was down 3 bp over the past week.

In the EM FX space, TRY (+1.4% vs. USD), ZAR (+1.0% vs. USD), and HUF (+0.7 vs. EUR) have outperformed over the last week, while CLP (-0.9%), BRL (-0.8%) and PKR (-0.7%) have underperformed.

(1) May Day brought fresh protests, and police repression, in Turkey. Thousands of protestors reportedly defied a ban on gathering on Istanbul’s Taksim Square after PM Erdogan told protesters to “give up hopes” to using it as a rallying point. As a result, teargas and water cannons were used against protests, along with 40,000 police officers. Assuming no major spike in violence tonight, there are unlikely to be broader consequences for now, especially Erdogan feels vindicated after his resounding victory in the March local elections. Still, it is reminder that tensions continue to simmer just beneath the surface.

(2) Meanwhile, there was more violence in China’s western province of Xinjiang. This time, the knife and bomb attack at a railway station killed three people and injured 79. Chinese President Xi vowed to “resolutely suppress” the attackers and pursue a “strike-first” strategy. The Xinjiang province, which borders Pakistan, is predominantly Muslim.

(3) The Brazilian central bank tweaks its FX strategy; polls confirm Dilma’s decline and street protests continue. The Brazilian real, which has been outperforming for weeks, has been stopped in its tracks after the bank decided last week not to continue the gradual rolling over of swaps contracts maturing on May 2nd, worth $8.7 bln. The expiry of these contracts (which had served to strengthen the BRL) suggests that authorities have had enough appreciation for now. This is very much in line with our long held view that – bar a huge external shock – USD/BRL will stay roughly within the 2.20-2.40 range at least until the presidential elections later in the year.

On the electoral front, according to the CNT/MDA survey, Dilma’s approval rate fell to 37% from 43.7% in February. This corroborates the previous poll by IBOPE, which pointed to a decline of similar magnitude. At the same time, street protests against the world cup and police violence continue to grip headlines. In what many are already considering a populist pivot by the government, Dilma has signed a decree yesterday that would increase by 10% the Bolsa Familia program for poor and a reduction in income tax.

(4) Mixed news for Ukraine as the situation continues to develop. The IMF has approved a $17 bln aid package via a 2-year standby agreement, including an immediate $3.2 bln. Some believe that part of the money will be used to pay off a $2.2 bln gas bill with Russia. The government committed itself to complying with the IMF-proposed reforms, including a fuel price hike. Meanwhile, acting president Turchynov admitted that security forces have lost control over the disputed eastern portions of Ukraine, in the Konetsk and Luhansk regions.

(5) Thailand announced new elections on July 20. This comes after the Constitutional Court invalidated the February 2 snap elections, which was boycotted by the opposition. It remains to be seen whether the opposition will also boycott the next elections, since it has so far shown no signs of backing down. Markets seem to have got accustomed to political tensions, as seen by the stable USD/THB and the outperformance of the Thai SET index, up about 15% year to date.

(6) Colombian central bank surprised markets with a 25 bp rate hike to 3.5% last Friday. Governor Uribe said a preemptive hike now will help avoid the need for sharper moves later, adding that the economy’s trajectory argues for a monetary stance that is “slightly less expansive.” We were surprised by the move given official concern with the exchange rate.

(7) Central Bank of Russia surprised markets with a 50 bp rate hike to 7.5% last Friday. The move came on the same day that S&P cut Russia’s rating by a notch to BBB- with a negative outlook. Our model rates Russia at BBB, but we acknowledge downside risks due to the unfolding economic sanctions. Indeed, the US announced another round of sanctions on Monday. We believe Moody’s Baa1 is way out of line and is likely to be cut soon. Also of note, the IMF cut Russia’s growth forecast from 1.3% to 0.2% for the year.

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