Emerging Markets: What has Changed

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

1) The US government shutdown and its impact on the economy and economic releases have pushed out Fed tapering expectations into 2014

2) There are growing signs that Korean officials may start to step up resistance against further won gains

3) The Brazilian swaps intervention program is turning into a political battleground

4) The UK and China have reached some remarkable agreements. To start with, China granted the UK a GBP8 bln QFII quota

Over the last week, Brazil (+5%), South Africa (+3%), and the Philippines (+3%) have outperformed in the EM equity space in local currency terms, while China (-1%) and Hungary (-1.5%) have underperformed.

In the EM local currency bond space, Brazil (10-year yield up 3 bp), India (up 17 bp), and the Czech Republic (up 13 bp) have underperformed over the last week, while Mexico (10-year yield down 23 bp), Indonesia (down 58 bp), and South Africa (down 18 bp) have outperformed.

In the EM FX space, MYR (+1%) and MXN (+2%) have outperformed vs. USD over the last week, while PEN (flat) and TWD (flat) have underperformed.

1) The US government shutdown and its impact on the economy and economic releases have pushed out Fed tapering expectations into 2014. This gives room for the EM rally to extend a bit more, especially as the resolution to the US debt crisis has also provided a further near-term boost to EM currencies. While uncertainty about Fed tapering will likely return to the spotlight at some point and hit EM, we look for a potentially longer period of EM gains near-term as US fiscal policy risks have been mitigated (for now).

2) There are growing signs that Korean officials may start to step up resistance against further won gains. The BOK is thought to have intervened heavily this week as USD/KRW grinds lower. In addition, the pressure from the Blue House (executive office) seems to be growing. Finance Minister Yoon Hyun sounded very dovish, pleading for the BOK to “refrain from raising rates for a while.” Note that Yoon is seen as possible replacement for BOK Governor Kim, even though he has previously stated that his is not interested in the post. 

Moreover, an official in the ministry’s FX division was quoted as saying the government is closely monitoring “herd behaviour” in FX markets. To be clear once again, we are positive in Korean assets, and think KRW could even gradually appreciate from here, depending on the broad USD direction. We just think the KRW out-performance in Asia is coming to an end, for now at least. Long SGD/KRW is one way to express this view.

3) The Brazilian swaps intervention program is turning into a political battleground. Local observers suggest that the infighting in the government and central banks about whether to reduce the swap intervention is reaching a climax. Allegedly, it was this infighting that caused a delay in announcing the swap amounts to auction for Thursday. 

Central bank chief Tombini is supposedly holding his ground, arguing that backtracking on intervention now would harm the bank’s credibility and also noting that a weaker dollar will help contain inflation. Let’s see how far Tombini can resist. A breach of the 2.15 will be the key event to watch. Meanwhile, COPOM minutes suggest another 50 bp hike is likely at the November meeting and should lead to an upward adjustment in market expectations of a 25 bp hike.

4) The UK and China have reached some remarkable agreements. To start with, China granted the UK a GBP8 bln QFII quota. But perhaps more interestingly, some Chinese banks will be allowed to expand a wholesale presence in the UK through branches, rather than just subsidiaries. In addition, other agreements including a nuclear deal and easier visa procedures for Chinese are in the works.