Emerging Markets: What has Changed

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

1) The tragic death of Eduardo Campos will change the electoral dynamics for the Brazilian elections in many ways

2) Ukraine central bank head Gontareva raised the possibility of "administrative" measures to support the currency, which is a step closer to capital controls

3) China’s lending numbers collapsed in July

4) Bank of Korea cut rates for the first time since May 2013

5) Protests against the Pakistan government are escalating

Over the last week, Russia (+6.3%), Czech Republic (+3.7%), and Peru (+3.5%) have outperformed in the EM equity space as measured by MSCI, while Argentina (-4.9%), Pakistan (-4.5%), and Israel (-1.6%) have underperformed. To put this in better context, MSCI EM rose 2.0% over the past week while MSCI DM rose 1.6%.

In the EM local currency bond space, Russia (10-year yield -46 bp), Hungary (-25 bp), and Poland (-18 bp) have outperformed over the last week, while the Philippines (10-year yield +8 bp), Peru (+5 bp), and Malaysia (+2 bp) have underperformed. To put this in better context, the 10-year UST yield was -1 bp over the past week.

In the EM FX space, ZAR (+2.2% vs. USD), KRW (+1.6%), and MXN (+1.4%) have outperformed over the last week, while PKR (-0.8%), CZK (-0.2% vs. EUR), and ARS (-0.1%) have underperformed.

1) The tragic death of Eduardo Campos will change the electoral dynamics for the Brazilian elections in many ways. In short, we would fade the initial negative market reaction as it opens up an entirely new set of possibilities. Marina Silva, Campos’ running mate, will probably run in his place. Her popularity and media attention will ensure a far more competitive first round contest, most likely to the detriment of Aecio Neves. For an in-depth analysis of the situation, please see our recent MarketView entitled "First Thoughts on Brazil Following the Death of Campos."

2) Ukraine central bank head Gontareva raised the possibility of "administrative" measures to support the currency, which is a step closer to capital controls. Press reports suggest the central bank has had to intervene several times in August as USD/UAH spiked to record highs in response to Russia tensions. IMF can't be happy that money is being used for FX intervention. Ukraine foreign reserves continue to melt away, falling $1 bln in July to $16 bln after a nearly $1 bln drop in June too. Reserves jumped $3.7 bln in May due to IMF money, but it's already lost about half of that. Gontareva added that the bank is "targeting" a "balanced" exchange rate of 11.5-11.9.

3) China’s lending numbers collapsed in July. Aggregate financing fell to the lowest level since 2008, and was lower than the new yuan loans print (a very rare event). The data would suggest that some loosening of monetary policy by the PBOC should be expected, but the bank was quick to dismiss the importance of the numbers. A statement posted on the PBOC website attributed the decline to seasonal factors, base effects, the reduction of wealth management products, and credit being diverted to IPOs.

4) Bank of Korea cut rates for the first time since May 2013. The benchmark rate was cut 25 bp to 2.25%, and is now just above the record low of 2% seen during the depths of the financial crisis. The decision was not unanimous, as one board member voted for steady rates. Governor Lee said the move should boost growth by 0.05-0.1 percentage point. Lastly, the October policy meeting was moved from the 8th to the 15th while the September meeting will be held on the 12th as planned. The won gained nearly 1% against the dollar after the cut, the biggest one day gain since April 9.

5) Protests against the Pakistan government are escalating. In short, the opposition has called for 1 million people to march from Lahore to Islamabad this week on Pakistan’s Independence day. The intent of the march is to bringing down the government led by Prime Minister Nawaz Sharif. The two leaders of the protest, Imran Khan and the cleric Tahir-ul-Qadri, claim that the last elections (in May 2013) were rigged. The government has deployed a large security force in the event that the protests turn violent. Over 20 people have died in protests so far, so potential for escalation is there. After being virtually flat lined for the last 3 months, the Pakistani rupee is down about 1% against the dollar.