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EM Strategy Summary - 3 November 2017

Core Content

This document outlines the current state and outlook of emerging markets (EM) strategies from BNP Paribas across various regions. It emphasizes the challenges emerging from a more hawkish US monetary policy environment, which is affecting EM markets, particularly those with weaker fundamentals or higher vulnerability to negative headlines. The report provides a detailed assessment of EM currencies, interest rates, and trade dynamics, along with specific trade recommendations and their performance.

Main Themes and Recommendations

Asia FX

• Take profit on short EUR vs INR: The EUR/INR short recommendation has reached its target, resulting in a 3.5% gain. The INR is expected to continue outperforming EM peers, and the team remains positive about its medium-term prospects.
• CLEER Road Ahead: The CLEER™ model suggests that KRW, IDR, and MYR are the best currencies to own over the next 12 months, while PHP, SGD, and RMB have the least upside. The model does not account for geopolitical risks, which could still impact certain currencies.
• Key Currencies:
  • Buy USDSGD: A $10mn position with a 0.22% gain.
  • Sell 3m EURINR NDF: A $10mn position with a 3.48% gain.
  • Sell 3m USDCNY NDF: A $20mn position with a 4.96% gain.
  • Short USDARS via 3m NDF: A $10mn position with a 3.08% gain.
  • Long BRL against a basket (CLP, EUR, AUD): A $15mn position with a 14.84% gain.
  • Long USDBRL OT 3.10 / Mat: 26-Jan-18: A $1mn position with a -4.53% loss.
  • Long USDMXN OT 20.0 / Mat: 10-Jan-18: A $2mn position with a 6.23% gain.
  • Long USDBRL CS k=3.175-3.35 / Mat: 29-Dec-17: A $30mn position with a -19.88% loss.

CEEMEA

• Burst of dependence: The TRY drawdown is approaching a critical level, indicating increased vulnerability. The team warns that further tightening of global liquidity could worsen the situation.
• Turkey: Inflation outlook has worsened, with the end-year CPI forecast revised to 11.2% y/y from 9.8% y/y. The chances of the CBRT raising the repo rate to 12.25% have increased.
• CEEMEA countries outside CEE: Seen as the most at risk due to weaker fundamentals and vulnerability to negative headlines.

Latam

• Brazil DI Strategy: The sell-off in IR and FX is driven by technical factors, not macroeconomic ones. The team expects yields on longer DI tenors to decline in the future.
• Mexico TIIE: The team maintains a 18m TIIE receiver position, believing the current pricing is favorable.
• Argentina: No changes to trade recommendations this week.

Key Information

US Policy Impact

• The US Federal Reserve is expected to raise rates in December 2017 and three times in 2018.
• The Fed's nomination of Jerome Powell as Chair is seen as a continuation of previous policies.
• US tax reform is expected to be delayed until Q2 2018, with uncertainty about its scale.
• The US bond curve is tightening, making the EM environment more challenging.

External Funding Capacity

• The external funding capacity scorecard (Table 1) shows that Gulf countries (especially Bahrain and Turkey) have experienced significant deterioration since 2013.
• Bahrain is highlighted as an opportunity, with potential for USD debt position additions due to its request for financial aid and fiscal reforms.
• South Africa and Turkey are noted as countries of concern due to external vulnerabilities and inflation risks.

EM Export Growth and Inflation

• EM export growth remains strong, with notable acceleration in Asia and CEEMEA.
• Inflation is low across most EM countries, though Turkey has seen a sharp increase to 11.9% y/y in October.
• External vulnerabilities have decreased since 2013, except for the Gulf region.

Currency Outlook

• KRW, IDR, and MYR are projected to appreciate over the next 12 months.
• PHP, SGD, and RMB are expected to have limited upside.
• USDSGD, EURINR, USDCNY, USDARS, and BRL have shown positive performance in recent trades.

Risk Factors

• Geopolitical risks remain a concern, especially for currencies like INR and BRL.
• FX volatility is in check for some EM currencies due to central bank interventions.
• Negative headline risks (e.g., political tensions in South Africa) can impact market sentiment.

Summary of Trade Positions

Summary of Performance

• Total P/L: -780 kUSD
• Rates: -3512 kUSD
• FX: +2566 kUSD
• Options: +353 kUSD
• Credit: -65 kUSD

Outlook for Next Week

• Asia:
  • Donald Trump's visit to China (8-9 Nov) will focus on trade and geopolitical issues.
  • Bank of Thailand (BoT) and Malaysia (BNM) and Philippines (BSP) central banks are expected to keep rates on hold but with different tones.
  • CPI data for the Philippines and trade data for China and Taiwan will be released, with China's trade balance expected to be weaker than consensus.
• CEEMEA:
  • Poland's monetary policy committee is expected to keep rates unchanged.
  • Czech Republic and Hungary will release October inflation data, showing a 0.1pp slowdown in inflation.
• Latam:
  • Mexico is expected to leave the policy rate unchanged, but the FX hedging program may prevent further weakness.
  • Brazil will release October CPI data, which is expected to show continued low inflation.

Conclusion

The EM strategy team recommends shortening portfolio duration and reducing exposure to countries with weaker fundamentals and higher vulnerability to external risks. While the US rates environment is more challenging, EM fundamentals remain strong, and certain currencies (like KRW, IDR, and MYR) are still seen as having upside potential. The team remains cautious about Turkey and Bahrain, but sees opportunities in Bahrain due to its financial aid request and fiscal reforms. Overall, the EM market is expected to continue to see capital flows into USD debt, with limited movement into equities or local funds.