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EM Strategy | Global Weekly - 27 January 2017

Core Content Summary

This document provides a comprehensive overview of Emerging Market (EM) strategy and credit performance as of 27 January 2017, authored by a team of strategists from BNP Paribas and Turk Ekonomi Bank A.S. It includes market analysis, trade reviews, and new recommendations, focusing on interest rates, foreign exchange (FX), and credit instruments.

Main Points and Key Information

EM Credit Performance and Outlook

• EM credit has shown strong performance in January, with a 1.49% year-to-date (YTD) total return on the EMBI.
• Despite this performance, the team remains cautious due to tight valuations and the potential for a medium-term gappy move if a US Treasury spike or EM-specific event occurs.
• The team retains the CDX EM vs CDX IG ratio trade, anticipating that EM credit may underperform US credit if the gap risk materialises.

Themes of the Week

1. China – Is RRR cut coming?

   • The PBoC raised the MLF rate and halted RMB depreciation.
   • The market is recalling the February 2016 RRR cut.
   • The PBoC seems comfortable with the USD/CNH spot rate below onshore spot.
   • Bloomberg/Barclays global bond indices will include CIBM.

2. Asian FX Positioning: Flat at last!

   • The short-covering rally in Asian currencies has ended.
   • Market positioning is now neutral for the first time since the US election.
   • The bar for further appreciation of Asian currencies has risen.

3. Turkey Credit: Fitch Rating Review and Banks' Eurobond Holdings

   • Even if capital adequacy ratios of Turkish banks fall below the BRSA target, raising capital may be more beneficial than selling eurobond holdings.

4. Mexico Q1 2017 = Brazil Q1 2016: Continue tactically

   • MXN levels are seen as far from fundamentals.
   • The peso is expected to appreciate, and the team starts going long MXN with a smaller allocation.

5. Brazil: Don't count on NTN-Bs to infer market expectations

   • Breakevens in Brazil are more influenced by nominal rates and current inflation rather than forward-looking expectations.
   • The premium or lack of prognosticative power remains.

New Recommendations

Trade Review

• Asia: Stopped out of the recommendation to buy 12m USDTWD.
• CEEMEA: Stopped out of the recommendation to receive ZAR 5y5y.
• Latam: Recommended going short USDMXN December 2017 forward and short USDARS 1-year NDF against long USDARS 2-year NDF.
• Take Profits: Taken on long Soberanos 2026 in Peru (FX unhedged) and long UDIBonos Jun19 in Mexico.

ETF Impact on EM Credit

• ETFs have a significant technical presence in the EM hard currency market.
• ETF holdings have decreased since the US election, but remain a key factor in market liquidity.
• ETFs are more likely to trigger passive sell-offs during systemic crises.
• The top ETF holdings include bonds from Russia, Turkey, Venezuela, Colombia, and Brazil.
• ETF concentrations have dropped for most of these names, but increased for Pakistan, ACIRC, and CNOOC.

Most Sensitive Bonds to ETF Flows

• Latvia '20s: 17% of bond amount outstanding.
• El Salvador '35s and '32s: 9% of bond amount outstanding.
• Kazakhstan '44s: 9% of bond amount outstanding.
• Sri Lanka '26s: 9% of bond amount outstanding.
• Serbia '20s: 8% of bond amount outstanding.

What's Up Next Week?

• Asia: Several markets will be closed for the Chinese New Year.
  • China: Holidays from Monday to Thursday.
  • South Korea, Taiwan, Hong Kong, Singapore, and Malaysia: Shortened workweeks.
• India: Budget presentation on 1 February, marking a departure from the previous tradition of a 'last day of Feb' event.
• The budget will be the first to consider the upcoming goods and services tax (GST) and may adjust duty rates accordingly.
• The Indian budget is expected to draw significant investor attention, especially in the context of demonetisation and upcoming fiscal policies.

Conclusion

The EM credit market has shown strong performance in January, but the team remains cautious due to valuations and potential for a gappy move. ETFs play a crucial role in market liquidity and could trigger sell-offs if there is a systemic event. The team has updated their positions and is monitoring key markets and instruments for further strategic moves.