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This article was first published on marktomarket.com

Emerging Markets: What has Changed

1) S&P revised Brazil’s BBB- rating from stable to negative
2) Banco de Mexico announced changes to its FX intervention program, which had been rumored since last week
3) The Russian central bank has halted its daily USD purchases and slowed its pace of easing
4) Turkey finally engaged the international community with regards to ISIS/ISIL, asking NATO to hold a rare emergency meeting
5) Turkey’s central bank is considering a move to a simplified monetary policy framework with one policy rate
6) Bank of America decided to keep EM companies in its Global High Yield Index
7) The government of India Prime Minister Modi is drafting a bill that is seen as limiting RBI independence
8) Ukraine’s creditors are starting to accept the notion of debt relief
9) Malaysian Prime Minister Najib Razak shuffled his cabinetIn the EM equity space, Russia (+3.5), Brazil (+1.8%), and Colombia (+1.4%) have outperformed over the last week, while China (-8.6%), Singapore (-4.5%), and Hong Kong (-2.0%) have underperformed. To put this in better context, MSCI EM fell -0.9% over the past week while MSCI DM rose 1.2%.
In the EM local currency bond space, Brazil (10-year yield -22 bp), Turkey (-14 bp), and Russia (-10 bp) have outperformed over the last week, while Indonesia (10-year yield +30 bp), Hungary (+19 bp), and Malaysia (+15 bp) have underperformed. To put this in better context, the 10-year UST yield fell -6 bp over the past week.
In the EM FX space, ILS (+1.4% vs. USD), MXN (+1.1% vs. USD), and HUF (+1.1 vs. EUR) have outperformed over the last week, while RUB (-3.6% vs. USD), CLP (-1.5% vs. USD), and TRY (-0.9% vs. USD) have underperformed.
1) S&P revised Brazil’s BBB- rating from stable to negative. The agency cited political and economic challenges amid an ongoing corruption probe as major factors for the move. In the most recent round of our EM sovereign ratings model, Brazil’s implied rating fell a notch to BB+/Ba1/BB+. Actual ratings of BBB-/Baa2/BBB are thus subject to increasing downgrade risk as the fiscal numbers continue to worsen. Indeed, the government’s recent cut in the primary surplus target for this year could be the trigger for a downgrade. Brazil has been rated investment grade by all three agencies since 2009. Note that a downgrade by S&P would take it to sub-investment grade BB+.
2) Banco de Mexico announced changes to its FX intervention program, which had been rumored since last week. Extraordinary dollar auctions will now be triggered by a 1% depreciation from the previous day’s fix (vs. 1.5% previously). Regular daily dollar auctions were increased from $52 mln to $200 mln. While we were not surprised by the changes, the announcement was enough to start a short-covering rally for the peso, which earlier in the day had hit a new all-time low near 16.50. It’s important to stress that the measures are really meant to provide extra liquidity in disorderly markets, and are not meant to protect a level or to reverse the trend.
3) The Russian central bank halted its daily USD purchases “due to volatility on the domestic currency market.” Lower oil prices have taken a toll on the ruble, and so the authorities are signaling discomfort with recent weakness with this halt to purchases. The central bank cut 50 bp rate this week. While expected, it is the smallest of the five rate cuts (totaling 600 bp) this year. Comments by the bank suggest that boosting growth is the main focus, and it forecasts inflation falling below 7% by July 2016 from 15.3% in June 2015.
4) Turkey finally engaged the international community with regards to ISIS/ISIL, asking NATO to hold a rare emergency meeting this week. This is only the fifth such meeting in NATO history, and reportedly discussed the establishment of a safe zone near Turkey’s border with Syria due to the ISIS/ISIL threat. Recent attacks in Turkey linked to ISIS/ISIL seem to have given Turkish officials a greater sense of urgency. NATO involvement is a positive step, although we would caution against any sort of quick resolution to the building problem.
5) Minutes from the July 23 policy meeting show that Turkey’s central bank is considering a move to a simplified monetary policy framework with one policy rate. It currently runs policy by managing liquidity within a corridor comprised of several rates. The bank has asked its technical units to complete these preparations and to submit them at the August policy meeting. The rates corridor was introduced over five years ago, and was roundly criticized for needlessly complicating matters. If true, the move should be seen as marginally positive since it would be a step back towards orthodoxy.
6) Bank of America decided to keep EM companies in its Global High Yield Index. However, it also decided to create 13 new high yield sub-indexes that excludes EM issuers. BOA had asked investors to vote on the matter as part of an annual review of its benchmarks. They voted to keep EM in, but “a large number” expressed interest in a DM-only index. EM companies accounted for 18% of the index at the end of March, and the decision was very important as exclusion would likely have led to some forced selling of EM debt.
7) The government of India Prime Minister Modi is drafting a bill that is seen as limiting RBI independence. In the current draft, the MPC would consist of 7 members: 3 from the central bank and 4 to be nominated by the government. The RBI Governor would cast the deciding vote in case of a tie. Clearly, this would give the government an outsized say in monetary policy. Representation on the committee has been a sticking point between Governor Rajan and Modi’s government in their efforts to set up a rate-setting structure similar to the Fed.
8) Ukraine’s creditors are starting to accept the notion of debt relief. Franklin Templeton and three other bondholders have offered Ukraine a haircut of 5% on its principal, and is the first time that a haircut has been discussed. Still, this is well below the 40% haircut that Ukraine reportedly asked for last month. While a compromise seems likely ahead of a September 23 eurobond maturity, the two sides remain far apart and so they need to pick up the pace of negotiations.
9) Malaysian Prime Minister Najib Razak shuffled his cabinet. Najib dismissed Deputy Prime Minister Muhyiddin after he made public remarks on the ongoing 1MDB investigations that were seen as critical of Najib. Muhyiddin was replaced by the more loyal Home Minister Ahmad. Some of the moves will affect the 1MDB investigations. The new cabinet contains four members of Parliament’s Public Accounts Committee, one of the groups investigating 1MDB. As a result, the probe will be halted until new members are named to the committee in October, when parliament reconvenes. The Attorney General, whose office is part of the 1MDB task for, will also be replaced “for health reasons.”

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