Watch These EM Trends

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

1. Korea’s President Park is keeping up the tradition of not respecting the central banks’ independence
2. The decision by the Swiss National Bank to remove the cap on EUR/CHF could have some negative impact on Hungary and Poland
3. Turkey’s government is also pressuring the central bank to cut rates
4. Brazilian assets have received a boost on positive headlines from the new economic team
5. Mexican state oil company Pemex announced 10,000 in job cuts
   
   Over the last week, Egypt (+6.4%), UAE (+3.4%), and Hong Kong (+3.2%) have outperformed in the EM equity space as measured by MSCI, while Peru (-6.3%), Russia (-4.8%), and Colombia (-4.4%) have underperformed. To put this in better context, MSCI EM rose 0.5% over the past week while MSCI DM fell -1.3%.
   
   In the EM local currency bond space, Turkey (10-year yield -28 bp), Indonesia (-28 bp), and Malaysia (-23 bp) have outperformed over the last week, while Russia (10-year yield +82 bp), Colombia (+3 bp), and Peru (+2 bp) have underperformed. To put this in better context, the 10-year UST yield fell 18 bp over the past week.
   
   In the EM FX space, BRL (+1.6% vs. USD), KRW (+1.3% vs. USD), and MXN (+1.3% vs. USD) have outperformed over the last week, while RUB (-6.5% vs. USD), HUF (-1.6% vs. EUR), and CLP (-1.6% vs. USD) have underperformed.
   
   (1) The Reserve Bank of India (RBI) started the easy cycle with a bang. In an unscheduled decision, the bank cut the repo and reverse repo rate by 25 bp each to 7.75% and 6.75%, respectively. Perhaps the most interesting part of the move is what we can infer from fiscal policy. We thought that RBI Governor Rajan would use the prospects of rate cuts later in the year as a “carrot” to help push along Prime Minister Modi’s fiscal tightening plans. So we infer that by choosing to cut now, Rajan is giving Modi a vote of confidence. Of course, the favorable backdrop was key. Food and energy prices are falling fast in India, and domestic demand is not as supportive. We see this move as positive for INR. Despite its high carry, flows to India continue to be dominated by the equity sector, which will benefit from lower rates and better growth prospects.
   
   (2) Korea’s President Park is keeping up the tradition of not respecting the central bank’s independence. The president was quoted saying that the government will discuss rates with the central bank (BOK) to find ways to revive the economy. Rates dropped as much as 8 bp in response. The yields on 2-Year bonds, for example, extended their decline to 1.95%, compared with 2.20% in December. We think this is another confirmation that rate cuts are on the way, even though the BOK left rates unchanged at 2.0% this week.
   
   (3) The decision by the Swiss National Bank to remove the cap on EUR/CHF could have some negative impact on Hungary and Poland. Although the country has gone a long way in restructuring its FX-denominated loans, there is still a lot of CHF-linked risk in the system. Hungarian banks have to convert around EUR8bln of FX-linked mortgages into forints, a large part of which is in francs. The conversion rate was set at CHF/HUF 256 (now around 315). The central bank will offer most of this amount from its foreign reserves (currently around EUR34 bln), so it depends on what share of its reserves is already in CHF. By some estimates, Poland has around 15% of total loans in CHF, as well as over 35% of its mortgages.
   
   (4) Turkey’s government is back to pressuring the central bank to cut rates. Authorities had somewhat laid off the central bank as the lira came under threat amid the broad dollar move. But with energy prices bring inflation lower, they are finding new impetus to start jawboning again. This time the lead was taken by Economy Minister Zeybekci. The big difference now is that a rate cut might actually be warranted now that inflation is falling sharply. We think a rate cut in Q1 is very likely.
   
   (5) Brazilian assets have received a boost on positive headlines from the new economic team. Local newspapers suggest that a new set of measures are coming out soon, which should include tax increases. In addition, electricity prices will be increased, possibly by as much as 40% to make up for the scrapping of subsidies (saving some 0.2% of GDP). Of course, this will have a material impact on CPI, but it increases the chances for the government to hit its 1.2% primary surplus this year.
   
   (6) Mexican state oil company Pemex announced 10,000 workers at oil service companies will be laid off. Pemex said that those affected were outside workers whose contracts were not renewed, rather than Pemex employees. To us, it really doesn’t matter from a macro perspective. Job losses are job losses, no matter who the employer ultimately is. Most of the job cuts are in Ciudad del Carmen, on the Gulf of Mexico. Official from that city’s Economic Development Chamber warned that job losses could climb to 50,000 there. While Banco de Mexico Governor Carstens has highlighted the risk of tighter policy this year, it will be difficult to do given the macro backdrop and low oil prices.