Emerging Markets: What Has Changed

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

1. The military coup finally did happen in Egypt

2. Brazilian President Dilma Rousseff approval rating collapsed

3. Turkish CPI surprised on the upside – by a lot

4. The Indian cabinet agreed to a doubling of natural gas prices

The MSCI Emerging Market equity index fell about 2.5% over the past week.  The move higher at the start of the week fizzed, which appears to have signaled the end of the 5-6 day correction.  With the robust employment data keeping speculation running high of Fed tapering followed by a rate hike as early as the end of next year, the unwinding of emerging market strategic positions is set to continue and the emerging market index is likely to make new lows.   Emerging market bonds appeared to fare a bit better, but it is too early to reach any meaningful conclusion.  

The weakest emerging market currencies over the past week were the South African rand (-2.9%), the Turkish lira (-1.9%) and the Brazilian real (-1.6%) . The strongest currencies were the Indonesian rupiah (0.6%), Chilean peso (almost 0.3%) and China's yuan (nearly 0.1%).  

1. The military coup finally did happen in Egypt. The army has suspended the constitution, removed President Morsi from office, and called for fresh presidential elections. A technocratic government will be formed in the interim, and no date was set for new elections. The move appears to have the blessing of opposition leader elBaradei as well as Egypt's highest religious leaders. The situation remains fluid, and we would warn investors not to get too optimistic just on this development.

Supporters of ex-President Morsi are staging protests and are likely to keep political tensions high. Much more needs to be done to stabilize the country's economic and political outlooks. USD/EGP is likely to march higher.

2. Brazilian President Dilma Rousseff’s approval rating collapsed. Favorable approvals fell to 30% from 57% earlier this month, and a high of 65% in March. Beyond this short-term legislative flurry in the congress, the ruling PT party could start to lose support from its allies quickly. From an economic perspective, the challenge is how to please the disenchanted electorate and boost the “stagflated” economy. As an immediate consequence, we think that the chance of a 75 bp hike by the central bank at the mid-July meeting has increased, and controlling FX depreciation and flows will take a greater degree of urgency.

3. Turkish CPI surprised on the upside – by a lot. June CPI came in at 8.3% y/y (vs. expected 7.6%), with food and transport the biggest culprits. In addition, PPI accelerated sharply from 2.2% in May to 5.2% in June, driven by agricultural prices.

Clearly, the disinflation the central bank expected is not going as planned. Still, we do not expect a policy response in terms of policy rates just yet – the focus is still on the currency. The central bank tightened liquidity within its rates corridor to help support the lira during the EM sell off, and then loosened liquidity last week as the markets stabilized. This week, they are back to tightening again. To us, the combination of high inflation and a widening current account are still negative for the lira.

4. (From last Friday) The Indian cabinet agreed to a doubling of natural gas prices. This is the first increase in three years. The idea, of course, is to reduce reliance on natural gas imports and stimulate domestic production. We have been very supportive of the measures the India government has been taking to tackle the current account deficit and reform the country’s economy. These measures should pay off in the medium- to long-term. Still, we think the currency is not yet on a solid footing in the near-term. Until markets truly stabilize again and equity inflows to EM return, we expect INR to be a prime under-performer during any risk-off period.