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EM Strategy Summary - June 16, 2017

Core Content

This document outlines the Emerging Markets (EM) strategy for the week of June 16, 2017, focusing on the impact of the US Federal Reserve's policy on EM capital flows, key market themes, trade recommendations, and insights into China's interest rate dynamics.

Main Views

1. Fed Threat to EM Flows

• The US Federal Reserve is expected to start reducing its balance sheet in July, which could limit inflows into EM and potentially trigger outflows.
• The reduction in the Fed's balance sheet, combined with rising US real rates, is likely to narrow the spread differential between the US and EM, making EM assets less attractive.
• Inflows into EM have been significant this year, totaling around USD 100bn (USD 60bn in bonds and USD 40bn in equities).
• A 10% elasticity of EM flows to the Fed's UST holdings reduction is expected, leading to a potential USD 18bn reduction in flows over the next 12 months.
• The team is preparing to reduce risk exposure and seek insurance through options as the second half of the year approaches.

2. EM Market Themes

• China: The rally in rates appears stretched. While no pay or steepening recommendation is activated, market levels and time frame are becoming interesting. The 5-year NDIRS has fallen to 3.73%, and the team recommends monitoring for potential support at 3.60%.
• Taiwan: Weaker macroeconomic data and outflows from the tech-heavy stock market may put downward pressure on the TWD. Recommendation: Buy 1m 25-delta topside risk-reversals in USDTWD.
• Turkey: Economic growth is recovering, and inflation expectations are unlikely to fall sharply. The central bank is expected to maintain a tight policy stance for most of the year. Recommendation: Remain a payer in short-end swaps.
• Qatar: Credit spreads have reversed some of their widening, but renewed pressure is expected with the potential release of demands for lifting sanctions.
• Colombia: The team has taken profit on USDARS 3m vs. 12m NDF steepener. Recommendation: Receive 5y TIIE in spread over US swaps and receive 5y TIIE against paying 5y IBR.
• Mexico: Expected to hike rates again, possibly by 25bp, to 7.00%. Recommendation: Receive 5y5y TIIE in spread over US swaps.

3. Trade Recommendations

4. Key Market Data and Insights

• China:

  • Swap rates have fallen due to PBoC's liquidity management.
  • The 5-year NDIRS has fallen to 3.73%, and the spread with CGB yields has narrowed significantly.
  • The repo market is in a calm state, with the 7-day repo fixing rate at 3.4%.
  • The 3m SHIBOR may still have room to rise, and the NDIRS curve is flattening.
  • The PBoC is exploring an interest rate corridor mechanism and has introduced new tools like SLF and MLF.
  • The team recommends monitoring the 5-year NDIRS and possibly entering long duration positions if the 3m SHIBOR falls.

• South Africa:

  • Headline inflation is expected to remain at 5.3% y/y in May.
  • The SARB is likely to cut rates by 25bp in September and further in November.
  • The 10y breakeven inflation expectations have fallen below the upper bound of the target range.

• Poland:

  • Industrial production and PPI inflation figures for May will be published.
  • The team is closely monitoring these to assess economic activity.

• Asia:

  • Central banks in Taiwan, the Philippines, and New Zealand will hold monetary policy meetings.
  • The Philippines BSP is expected to take a hawkish stance.

• Latam:

  • Mexico's monetary policy decision on June 22 is the main focus.
  • The team expects a 25bp rate hike, potentially pushing the policy rate to 7.00%.
  • The currency has moved rapidly to the team's forecast of 18.00, but rates have lagged the move.

Key Information

• The Fed's balance sheet reduction and rising real rates are likely to limit EM inflows and may encourage outflows.
• The team is taking a cautious approach, removing risk and seeking insurance through options.
• China's interest rate market is complex with multiple tiers and curves, and the 5-year NDIRS is expected to stabilize or find support at 3.60%.
• The team has taken profit on some positions and made new recommendations based on market dynamics.
• Macroeconomic data from various EM countries is expected to influence policy decisions and market movements.

Summary of Recommendations

• Buy USDTWD 1m 25-delta topside risk-reversal
• Buy USDINR 3m 66.10 put, financed by selling 64 - 66 strangle
• Receive 5y TIIE in spread over US swaps and receive 5y TIIE against paying 5y IBR in Colombia
• Switch from Poland $24s into Hungary $24s
• Monitor 5-year NDIRS and consider entering long duration positions if 3m SHIBOR falls

Summary of Key Markets

• China: Interest rate dynamics are complex with multiple tiers. The 5-year NDIRS has fallen to 3.73%, and the team is cautious about further rate hikes.
• Taiwan: Weaker data and outflows from the tech-heavy stock market may pressure the TWD.
• Turkey: Economic growth is recovering, and the central bank is expected to maintain a tight policy stance.
• Qatar: Credit spreads may face renewed pressure as sanctions are lifted.
• Mexico: Expected to hike rates again, possibly by 25bp, and the team recommends receiving 5y TIIE in spread over US swaps.
• South Africa: The SARB is likely to cut rates by 25bp in September and further in November.
• Poland: Industrial production and PPI inflation figures will be published for May.

Conclusion

The EM strategy team is monitoring the impact of the Fed's policy on EM flows and adjusting positions accordingly. The team is cautious in China's rate market and recommends options to hedge risk. In other regions, the focus is on monetary policy decisions and macroeconomic data that may influence market movements. The team is preparing for potential rate hikes and is looking to reduce risk exposure as the second half of the year approaches.