The carnage you’re seeing across emerging market capital and currency markets is exactly what we anticipated when we first went broadly negative on this investment space back in early 2013 – a view that received a fair amount of pushback at the time.
While the path to get here was anything but linear – i.e. full of intermittent reflation rallies that we had to risk manage or take advantage of select opportunities on the long side for a trade(s) – we’ve maintained a bearish bias on EM with respect to our intermediate-term TREND and long-term TAIL durations throughout the entirety of the move and many of our clients have benefitted tremendously from this research view over the past few years.
Given that EM is now a consensus short, we don’t necessary have much more to add to the discussion at the current juncture. That said, however, it’s important to contextualize how we got here so that we can better position ourselves for either incremental carnage or an investable bottom. As such, we think the following sampling of our work on EM/global dollar tightening from the past few years is a good place to start:
- Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle (4/23/13)
- Are You Prepared for #Quad4? (8/5/14)
- #EmergingOutflows Round II: This Time Is Actually Different (12/16/14)
- Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions? (10/22/15)
- Can Beijing Maintain Exchange Rate Stability Or Is the Chinese Yuan the Next Thai Baht? (11/19/15)
Source: Bloomberg L.P.
In terms of evaluating incremental data, we complied the following country capsules to: A) provide an update on the individual economies listed below, as well as B) provide our overarching thoughts on the space at this historic moment in time. Remember, the Fed has never hiked rates into an obvious #LateCycle Slowdown. The next few months could be very interesting…
Best of luck out there! Email us if we can expound upon anything; always happy to help.
In China, the month of November registered a sequential pickup in CPI, but headline inflation is still decelerating on a trending basis. Moreover, the persistent and deeply negative PPI in conjunction with the sequential deceleration in FDI speaks volumes to the ongoing deflationary pressures emanating throughout the Chinese economy. The NOV credit and money supply data was positive, on the margin, and confirms the Chinese economy is not “rolling down the hill” (as we’ve previously termed), but rather continuing to be “walked down the stairs” by policymakers. Economic data aside, the most impactful headline out of China this week has to be the PBoC’s decision to set the CNY reference rate to 6.4385 – which is the lowest value per USD since August 2011. Following this maneuver was the headline of the week in the PBoC signaling that it intends to change the way it manages the yuan’s value by potentially loosening its peg to the U.S. dollar. Specifically, the PBoC said it makes more sense to measure the yuan’s exchange rate against a basket of currencies rather than the USD alone, and that referencing the yuan against a basket of currencies would help keep its value at a reasonable equilibrium. This confirms our view that the PBoC fully intends to materially devalue the CNY vs. the USD and likely speeds up the process by which said devaluation will occur – something we did not see coming. That said, however, we still don’t think the CNY will suffer a major one-off devaluation(s) in line with what we saw in August, but rather a multi-year revaluation lower vs. the USD to improve its competitiveness against peer currencies (namely the JPY, KRW, MXN, TWD and THB). Unrelated, we find it interesting that this headline leaked just days before the FOMC meeting begins; this is not unlike the August devaluation ahead of the September 17th FOMC statement. Will China force the Fed’s hand on liftoff (or the lack thereof) for the second time in 2015? Investment conclusion: We previously held a neutral bias on China, but today’s news of the pending change to the CNY policy has us thinking more volatility is ahead over the immediate-to-intermediate term. As such, we are downshifting to underweight.
In India, capital and currency markets are under pressure as they look through the sequentially strong OCT industrial production report and focusing on two policy catalysts – one domestic (i.e. Modi’s inability to push through GST legislation amid opposition protests to recent corruption charges) and one foreign (the December 16th FOMC statement). The INR is threatening to record a new all-time low as the country’s twin deficits in the current and fiscal accounts perpetuate capital outflows, at the margins. Investment conclusion: We reiterate our underweight bias on India.
In South Korea, the BoK held its Benchmark 7-Day Repo rate flat at 1.5%, which marks the sixth straight month of being on hold after -50bps of cuts in 1H15. While their statement was dovish in terms of them highlighting external risks to their 2016 GDP growth and headline inflation forecasts of +3.2% and +1.7%, respectively, the South Korean economy is clearly developing a hawkish #Quad2 setup heading into 1Q16. Like many EM currencies, the KRW is getting smoked ahead of the Fed statement, but we would expect the won to outperform on a longer duration once the dust settles. Investment conclusion: We reiterate our neutral bias on South Korea.
In Brazil, the country’s stagflationary recession and political crisis deepened again this week, with headline inflation accelerating to new highs in NOV and tensions heating up between Finance Minster Joaquim Levy (a fiscal hawk) and Planning Minister Nelson Barbosa (left of Levy) over next year’s primary budget surplus target. The BRL – which may break to a new all-time low soon – is getting blown out alongside rates amid these negative developments. Investment conclusion: We reiterate our underweight bias on Brazil. Twin deficits? Check.
In Mexico, both headline and core inflation ticked down in NOV, which perpetuated a sequential improvement in real wage growth. Despite that, same-store sales growth decelerated sharply in the same month, which is indicative of the loss of purchasing power associated with the MXN’s -6.4% plunge over the past three weeks to new all-time lows. The Mexican economy is currently in an obvious #Quad4 state and short rates are pricing in the risk is that it slides over into stagflationary #Quad3 in fairly short order – an outcome that would inhibit Banxico from responding with easier monetary policy. Investment conclusion: We reiterate our underweight bias on Mexico. Twin deficits? Check.
In Russia, it was an uneventful week in terms of reported sequential deltas, with 3Q real GDP coming in unchanged vs. 2Q at -4.1% YoY and with the Central Bank of Russia holding its Benchmark Key Rate steady at 11%. The Russian economy had completed its transition from stagflationary #Quad3 to deflationary #Quad4, but the -8% plunge in the RUB over the past three weeks (threatening a new all-time low vs. the USD) threatens to perpetuate a hawkish inflection in headline inflation over the near term, which would keep CBoR in its box (it hasn’t cut rates since July after cutting them -600bps in the YTD. Investment conclusion: We reiterate our underweight bias on Russia.
In South Africa, recent economic data has come in in fairly mixed – which is a good thing, on the margin – as accelerating headline CPI in NOV and decelerating consumer confidence in 4Q contrasts with decelerating core inflation (NOV) and accelerating retail sales in OCT. From a trending perspective, the South African economy is still mired in stagflationary #Quad3, which is being perpetuated at the margins by the flaming ZAR (down -11.9% over the past three weeks to new all-time lows). Also weighing on the ZAR is a sharp increase in political consternation, as President Zuma’s recent decision to fire Finance Minister Nhlanhla Nene (a fiscal hawk) comes after a very public disagreement between the two regarding the path for government spending. Nene was replaced by little-known David van Rooyen, who is unlikely to oppose the president’s plans to move forward with proposals to build a nuclear-power industry, bailout the state-owned airline and push other spending before local government elections next year. Investment conclusion: We reiterate our underweight bias on South Africa. Twin deficits? Check.
In Turkey, real GDP accelerated in +20bps in 3Q to +4% YoY in line with the recent and material positive inflections registered across the preponderance of Turkey’s key high-frequency growth indicators. With various measures of Turkish inflation also accelerating on both a sequential and trending basis, the Turkish economy has clearly moved into #Quad2. So why are the Borsa Istanbul 100 Index (down -14% MoM) and the TRY (down -5% vs. the USD over the past three weeks) getting tattooed ahead of next week’s FOMC statement? The answer is simple: twin deficits have a tendency to perpetuate capital outflows amid global dollar tightening episodes. Turkey’s equity and rates markets are signaling that CBT will have to get serious about defending the currency – which is threating a new all-time low – in short order. Unfortunately for global capital allocators and Turkish consumers, the political situation may prevent them from implementing meaningful measures. Investment conclusion: We reiterate our underweight bias on Turkey.
Japan is obviously not an Emerging Market, but our long-held structural bearish bias on the Japanese yen (yes, we authored the Japan reflation thesis too) is partially why we are so bullish on the USD and bearish on EM. As such, Japan deserves an update as well… The latest batch of NOV/4Q growth data came in soft, with machine orders and PPI ticking up but remaining in negative territory and the 4Q MoF Survey declining sharply QoQ. Additionally, a Japan Center for Economic Research survey that showed economists’ estimates for CPI over the long run (i.e. FY17-FY21) ticking down -10bps vs. the prior survey (1.3% vs. 1.4%) – the first such decline since the BoJ launched its QQE program in April 2013. We still think QQE expansion is months away largely based on the BoJ’s guidance, but, on the margin, these latest developments pull that catalyst forward to a noteworthy extent. Investment conclusion: We reiterate our overweight bias on Japan.