Regular readers of our Emerging Markets (EM) weekly blog will notice a two-week absence. After one proposal, two lockdowns and three rearranged weddings, I have finally managed to tie the knot with my long-suffering partner Eloise. While wedding bells were music to my ears, one could not escape the distant sound of alarm bells in EM over the last few weeks. It has been a complicated period for market participants in our asset class, with sentiment buffeted by an increasingly hawkish Federal Reserve (Fed), the surprise RRR cut in China and the fervent debate over “peak” global growth. With a confluence of factors further complicating the backdrop for EM, one might have expected a significant period of weakness in our asset class. Not so. While the last few weeks have undoubtably been soggy, there has been no sign of the market volatility akin to the Q1 rout. Why? As outlined in our EAGLEi Blog from June 19th (A Busy Week for EM – Geopolitics & Central Bank Decisions), while the economic recovery is likely to remain uneven, we believe that with further fiscal stimulus entering the system, the foundations for the cyclical rebound are solid. This backdrop is likely to support allocations to some emerging market rates and currencies; we continue to favour the EM economies which have a strong beta to the cyclical upswing and the demand for commodities/capital goods. Furthermore, from a positioning standpoint, the prospect of a disorderly emerging market selloff remains low in our view; following the Q1 sell-off, most emerging market participants are already in a defensive posture. From an EM specific standpoint, it was a busy week for central bankers, with policy decisions due from the Bank Indonesia, South African Reserve Bank and Central Bank of Russia.
Bank Indonesia – Under Pressure
With Indonesia the new epicentre of the pandemic in Asia, it was not a huge surprise that the policy rate was left unchanged at 3.5% for the fifth consecutive meeting. Nor was it surprising that Bank Indonesia was forced to moderate its outlook for this year, with GDP downgraded from 4.1-5.1% to 3.5-4.3% for 2021. In response to the growing threat of the delta variant, the Governor promised to maintain a “pro-growth” policy well into next year; “Next year - macroprudential policies, payment systems, financial-market deepening, MSMEs, Islamic-finance economy - are all for pro-growth”. Likewise, the BI reiterated that it will continue with its asset purchase programme in the primary market; it has purchased close to IDR 125trn bonds YTD. Looking forward, we believe that while the vaccination programme continues to underwhelm – with just 6 % of the population fully immunized – the disruptive impact of the Delta variant is highly likely to hinder the Indonesian recovery over the coming months. Sadly, the Indonesian experience is playing out across other Southeast Asian economies, with Malaysia and Thailand, in particular, feeling the strain. On the desk, we are cautious when it comes to these economies which are suffering from vaccine shortfalls and are vulnerable to COVID flareups; they are highly likely to suffer from a shallow recovery and significantly lag the global hiking cycle. As such, we are neutral the IDR and like to play the low yielding Asian economies from the short side.
South Africa Reserve Bank – Standing Pat
Much like its Southeast Asia peers, South Africa is also suffering the negative implications of the Delta variant and a vaccination shortfall. If the story wasn’t complicated enough, the country continues to grapple with a deadly wave of civil unrest, which has flared in the aftermath of the arrest and incarceration of former president Jacob Zuma. Against this complicated backdrop, this week, the South African Reserve Bank (SARB) held rates at 3.5% for a sixth straight meeting. We note a dovish shift within the announcement; the decision to hold rates unchanged was unanimous among the MPC, contrary to market expectations of split vote with hawkish dissenters. A further dovish shift was also clear within the SARB implied rate projection model, which reflects just one 25bp hike this year, down from two 25bp hikes in the May MPC forecasts. Contrary to its contemporaries at the BI, there was little change in the forecasts; GDP estimates were left unchanged with the stronger than expected growth momentum in Q1 likely to offset the downside risks from recent social unrest, which were flagged by the SARB Governor in the accompanying communique; “Recent events in the country, their impact on vaccinations, a longer-than-expected lockdown, limited energy supply and policy uncertainty pose downside risks to growth”. Much like our outlook on the IDR, given the challenging COVID backdrop, combined with ongoing social unrest, we are also cautious when it comes to the ZAR, where we have a neutral stance.
Central Bank of Russia – Subtle Dovish Adjustment
To round off a busy week for emerging market central banks, in line with market expectations, the Central Bank of Russia (CBR) raised the base rate by 100bps to 6.5% on Friday. This is the largest hike since 2014. There was a notable shift within the accompanying forecasts; the GDP outlook for this year increased from 3.0-4.0% to 4.0-4.5%, while the CPI outlook was raised from 4.7-5.2% to 5.7-6.2%. Despite the upgrade to the growth and inflation outlook, we do note a subtle shift within the guidance statement, where there is no pre-commitment to tightening next month; “the Bank of Russia will consider the necessity of further key rate increase at its upcoming meetings". While the CBR is likely still biased to hike further, in our opinion, the change in guidance suggests greater data dependence and the possibility of a pause at the August meeting. The hiking cycle could be closer to the end than the beginning. As such, we believe that OFZ (Treasury bonds) overweights relative to other markets, particularly those who are just commencing their post-COVID hiking cycle, is an interesting opportunity.
Final Thoughts:
As noted in our EAGLEi blogs over recent weeks, we are cautious when it comes to emerging markets. In our view, the backdrop is complicated by peaking monetary policy support the United States, the spread of the coronavirus delta variant which is disproportionately hitting emerging relative to developed markets and the prospect of a moderate growth slowdown in China. While the backdrop is certainly complicated for the emerging markets, we believe that opportunities remain in our asset class. With further fiscal stimulus entering the system at home and abroad, the foundations for the cyclical rebound are solid; this backdrop is likely to support allocations to some emerging market rates and currencies, particularly those with a strong beta to global trade and commodities. Likewise, we look for cases of policy divergence within the emerging markets; we believe that cross market opportunities exist in markets where hiking cycle is maturing, relative to those who have barely began. We also favour markets which still have robust structural underpinnings despite the emergency support measures to fight the pandemic. In sum, we are on the lookout for emerging markets which have the following factors; beta to the global recovery/demand for capital goods and commodities, solid underlying fiscal dynamics, stable domestic politics, steeper curves and rewarding real yields.
Data sourced from Eurizon SLJ Capital Ltd & Bloomberg as at 11th June 2021. ESLJ-240721-I1
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