What a week...
As noted in last week’s blog, we believe the backdrop is becoming increasingly complicated for the emerging markets. These challenges were clear to see over the last week, with our asset class buffeted by political headlines and a string of central bank announcements at both home and abroad. It is of no surprise that it has been a soggy weak in the emerging market complex; there has been much wood to chop. The biggest talking point for EM once again came from abroad, with the hawkish pivot at the Federal Reserve shaking our asset class. The speculative positioning which has built over recent weeks, fuelled by the expectation of a quiet summer for the FOMC, has been particularly vulnerable. Looking forward, while the change in Fed reaction function is an unwelcome development, we do not anticipate a “taper-tantrum” event last seen in mid-2013. Why? In our view, much of the “heavy lifting” in preparation for a higher-yielding environment was completed during the Q1 selloff. In other words, positioning is nowhere near as long as it was back in 2013, with market participants already in a defensive posture following the early year volatility. Outside of the communication adjustment at the Fed, it has been a busy week for EM on the ground.
CE3 - Increasing Divergence
Early in the week, a flurry of hawkish comments from the Czech National Bank (CNB) and the National Bank of Hungary (NBH) continued to pave the way for policy tightening later this month. At the CNB, the first committee member called for a hike in June, rather than waiting for August. Likewise, at the NBH rate hikes were called for this month by a board member, cautioning the dangers of waiting too long to tighten policy. Conversely, the NBP continues to push back expectations of tightening in consort with the CNB and NBH; we had no fewer than three MPC members with dovish statements, signalling that it is too early to lift rates, which won’t be discussed before the end of Q3. The disparity between CE3 policy makers is now clear to see in the market implied policy rates over the next three months, with +35bps and +52bps of hikes expected by the CNB and NBH; there is just +11bps of tightening expected by the NBP.
Turkey - Presidents Meeting
Elsewhere, market participants were keenly following the much-anticipated meeting between the U.S. and Turkish Presidents at the NATO summit. Despite conciliatory comments from the Turkish President in the run up to the meeting, expectations of a breakthrough at were low. That said, we did note positive noises from both sides after the get together, with the meeting described as “positive” “productive” and “sincere”. Looking forward, both sides have also committed to further discussions. In terms of the market reaction, the knee jerk rally in the TRY quickly faded as the President of Turkey stated soon after “the Turkish stance on the S-400S remains unchanged”. In a busy schedule for Turkey, the TRY remained soggy ahead of the CBT decision later in the week.
Russia - Presidents Meeting
Mid-week market focus shifted to the U.S-Russia summit in Geneva. Much like the U.S.-Turkey meeting earlier in the week, there were low expectations of a thawing of the frosty relations between the two. Once again, the early headlines out of the meeting were positive, with goodwill from either side; notably ambassadors will now be returning to each capital. The initial knee jerk appreciation in the RUB quickly gave way as later headlines suggested significant disagreements remain, particularly in relation to cyber-attacks and human rights.
Central Bank of Brazil – Hawkish Tilt
Mid-week, the Central Bank of Brazil lifted the Selic rate by 75bps to 4.25%, the third straight hike of this magnitude since the normalization process began in March. One would think hiking by 75bps is hawkish in itself; however, the most notable hawkish tilt was in the supplementary statement, where the term “partial normalisation” was substituted by “full normalisation to neutral”. Likewise, COPOM signalled a further another 75bps hike in August's meeting; the committee “foresees the continuation of the normalisation process with another adjustment of the same magnitude”. The hardening of the hawkish language was also accompanied by the signal that the tightening bias could be pushed even further if inflation continues to accelerate. While political risks remain in Brazil, we believe that the BRL offers a selective opportunity to participate in one of the most aggressive tightening cycles in the emerging market complex.
Central Bank of Turkey – Sting in the Tail
Towards the end of the week, all eyes were on the Central bank of Turkey (CBT); while the decision to leave rates unchanged was warmly welcomed, there was a fly in the ointment when it came to the accompanying MPC statement; “taking into account the high levels of inflation and inflation expectations, the current tight monetary policy stance will be maintained decisively". The description of the current policy stance as “tight” seemed to spook market participants, which did little to alleviate the pressure on the TRY. Taking a step back, while the lira has had a soggy week, we have been heartened by how resistant the notoriously volatile currency has been in the face of a surprisingly hawkish Fed, noise around the U.S.-Turkey meeting and the funky language used by the CBT. In our view, this is largely a function of light positioning, improving data on the ground and progress in the Turkish vaccination programme.
Final Thoughts
As noted last week, on the desk, we remain cautious when it comes to emerging markets. In our view, the backdrop is complicated by peak monetary policy stimulus at home and abroad, combined with the well documented geopolitical risks mentioned above. In our view, while monetary policy support is undoubtably peaking, we believe selective 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. We continue to favour the EM economies which have a strong beta to the cyclical upswing and ongoing demand for commodities and capital goods. Likewise, we prefer EMs which have robust structural underpinnings and the capacity to provide the required support to emerge successfully from 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 discipline, monetary policy capacity stable domestic politics, steeper curves and rewarding real yields.
Sources
https://www.bloomberg.com/news/articles/2021-06-14/central-banker-favors-june-liftoff-for-czech-interest-rates
https://www.reuters.com/article/easteurope-markets-idUSL5N2NX28P
https://www.bloomberg.com/opinion/articles/2021-06-16/don-t-look-at-the-fed-for-inflation-answers-brazil-india-offer-better-lessons
https://www.bloomberg.com/news/articles/2021-06-17/turkey-to-hold-rates-as-lira-weakness-persists-decision-guide
Data sourced from Eurizon SLJ Capital Ltd as at 19th June 2021. ESLJ-190621-I1
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