***Below are our latest thoughts on the key economies throughout Asia, Latin America and EEMEA. Please feel free to email us if you'd like to dig into a specific economy further or if you'd like to request analysis on a country not mentioned below.***
In China, officials continue to push back on a material devaluation of the CNY while concomitantly defending the currency with near-peak FX reserve deployment and incremental capital controls. While we remain explicitly bearish on China’s intermediate-to-long-term growth outlook, as well as the nation’s capital and currency markets, we continue to believe the path lower will remain piecemeal in nature, rather than sharp and/or sudden. To the extent that expectation is proven correct, we think the best way to profit from our view will be through shorting Chinese stocks and regional peer currencies – rather than the yuan itself – because the bearish overhang of CNY devaluation risk is set to persist indefinitely. Contrary to growing consensus among investors, we still believe the Chinese yuan is unlikely to go the way of the Thai baht, Philippine peso, Malaysian ringgit, Indonesian rupiah or South Korean won circa 1997-98. It’s decline will more than likely resemble that of an advanced economy’s currency – which means credit expansion and broader economic growth will continue to meaningfully decelerate amid tighter-than-necessary financial conditions on the mainland. That outcome will surely put Chinese corporate balance sheets and Beijing’s desire for incremental bail-outs to the test. All told, slower-for-longer in China = structurally-depressed-for-longer with respect to commodity prices, as well as the respective outlooks for global growth and inflation.
In Japan, the introduction of NIRP has backfired aggressively with the Nikkei 225 down -9.4% WoW and the JPY up +4.2% WoW vs. the USD amid growing concerns about the efficacy of Abenomics. Complicating matters is the stagflationary #Quad3 setup implied by the preponderance of key high-frequency economic data, which is squeezing Japanese consumers at the margins. The BoJ will likely look to do more, but with JGBs yielding negatively across the curve through the 10Y maturity and select corporate bond issues following suit, you have to wonder about the efficacy and impact of further easing on risk assets in Japan. With their reputations and credibility at stake, look for Kuroda and Abe to materially ratchet up the scope of monetary easing in Japan over the next few months. But with the growing risk of a complete and recognized failure of Japanese monetary policy, we remain comfortably on the sidelines for now, having tactically (and appropriately) avoided much of the Abenomics unwind trade seen in recent weeks.
In India, liquidity continues to dry up amid RBI support of the INR. This tightening of domestic financial conditions has not been well-received by the nation’s capital and currency markets – which themselves continue to price in the stagflationary #Quad3 setup implied by the preponderance of key high-frequency economic data. All told, we reiterate our bearish bias on India’s capital and currency markets.
In South Korea, the preponderance of key high-frequency economic data implies a deflationary #Quad4 setup. That, in conjunction with the advent of NIRP weighing on sovereign yields across Europe and Japan appears to be underpinning dovish expectations for the BoK, which, in turn, appear to be driving foreign portfolio flows into South Korea’s bond market. That said, however, we are comfortable fading the recent positive deltas seen in Korean stocks and the KRW, as the fundamentals (i.e. #Quad4), nor sentiment (i.e. bearish CNY overhang) appear set to materially inflect anytime soon.
In Australia, the preponderance of key high-frequency economic data implies a hawkish #Quad2 setup. With the RBA effectively guiding to a #Quad3 outcome per its recent Q4 Monetary Policy Statement, we think this divergence is potentially being priced into the AUD. Like South Korea, the Aussie rates curve may be benefitting from foreign portfolio flows emanating from NIRP and NYSD (i.e. “Negative-Yielding Sovereign Debt”) in Europe and Japan. The All-Ordinaries Index looks most mispriced relative to the country’s depleted structural growth outlook, pervasive commodity price deflation and an overreliance on wholesale funding across the Aussie banking industry. As such, we anticipate more downside.
In Taiwan, the preponderance of key high-frequency economic data implies a hawkish #Quad2 setup, which is positively impacting the TWD. We expect this relative currency stability to continue and for it to positively impact Taiwanese stocks – at least on a relative basis vs. peer economies. That said, however, the bearish CNY overhang is a key risk for Taiwan’s capital and currency markets given the strength of the TWD on a nominal effective exchange rate (i.e. NEER) basis and the structural weakness in Taiwanese industrial production and export growth. As such, we think it’s best to adopt a neutral approach here.
In Indonesia, the preponderance of key high-frequency economic data implies a bullish #Quad1 setup, which itself is being priced into Indonesian financial markets with both the IDR and JCI up on a 1-3 month basis. Indonesia is a current account deficit economy, so its sovereign debt market is also reacting accordingly to the aforementioned positive economic news, as well as BI’s recent -25bps cut to the policy rate. With the DXY still bullish from an intermediate-term TREND perspective, we don’t think it pays to be naked long of any emerging market asset. That said, however, we want to be positively exposed to Indonesia’s capital and currency markets on a relative basis within EM. A breakdown in the USD would make us explicitly bullish from an absolute return perspective as well.
In Thailand, the preponderance of key high-frequency economic data implies a hawkish #Quad2 setup, which itself is being priced into Thai financial markets with both the THB and SET up sharply on MoM basis. We also highlight the sharp bull flattening seen in the country’s sovereign debt market as evidence of a reversal in foreign portfolio flows. Much like in Taiwan, however, the bearish CNY overhang is a critical risk given the strength of the THB on a NEER basis and the structurally depressed nature of Thai export growth. As such, we think it’s best to adopt a neutral approach with respect to Thailand’s capital and currency markets.
In Brazil, the preponderance of key high-frequency economic data implies a stagflationary #Quad3 setup, but the Bovespa and BRL are daring investors to chase the recent pullback in the DXY. Don’t – at least not in Brazil. The divergence between short-term sovereign debt yields and OIS spreads and long-term breakeven rates implies the country’s political dysfunction has yet to crescendo. Moreover, with BCB out to lunch with respect to its 2016 inflation forecast, there is a fair amount of risk that Brazilian policymakers have to aggressively tighten throughout 2016. Whether or not the political environment allows for that is beside the point. Both outcomes (i.e. tightening or political dysfunction that delays necessary cyclical responses and/or structural reforms) should continue to be bad for Brazil’s capital and currency markets – which we remain resoundingly bearish of.
In Mexico, Banxico has shifted its attention from “keeping up with the Joneses” (i.e. monetary tightening by the Federal Reserve) to focusing on its own issues – which predominately include a currency that’s crashed to all-time lows on a NEER basis; we are adding the obvious stagflationary #Quad3 setup being implied by the preponderance of key high-frequency data to that equation as well. The obvious risk to investors here is that Banxico follows through on its incremental guidance and steps up the pace of tightening. While that might provide some short-term reprieve to the MXN, we can’t see how the MXN-dominated assets respond well to the rising probability of that outcome. As such, we feel comfortable reiterating our bearish biases on Mexico’s capital and currency markets.
In Russia, the preponderance of key high-frequency economic data implies a deflationary #Quad4 setup. Moreover, the fact that Russian policymakers are out shopping global banks for international debt placement that will help plug the country’s widened fiscal deficit amid international sanctions and a rising cost of capital shines light on just how dire the country’s economic situation remains. Nothing has changed here fundamentally and Russia’s capital and currency markets are generally responding appropriately. As such, we feel comfortable reiterating our bearish bias on both.
In South Africa, it’s probably too soon to suggest that economic growth has sustainably inflected. That said, however, “green shoots” imply the country may be moving from a stagflationary #Quad3 setup to a hawkish #Quad2 setup. The SARB board has certainly responded in kind with a +50bps hike late last month. This incremental soundness has benefited the ZAR, on the margin; it’s “only” down -3.7% YTD after falling -15.7% in the final six weeks of 2015 alone. While we commend South African policymakers for finally getting serious in their response to the country’s currency crash to all-time lows on a NEER basis, the outlook for accelerated tightening is likely to quash the nascent recovery in growth and weigh incrementally on the prices, liquidity and valuations of ZAR-denominated assets. As such, we find it prudent to reiterate our bearish bias on South Africa’s capital and currency markets.
In Turkey, the preponderance of key high-frequency economic data implies a hawkish #Quad2 setup, which itself is being priced into the TRY in recent weeks. While we are predisposed to have a bullish bias on a country that is recording a sustained positive inflection in economic growth, narrowing spreads in the OIS market and a bull flattening in the country’s sovereign yield curve would seem to suggest Turkish policymakers aren’t serious about deferring to the improved growth backdrop as cover to promote a commensurate (i.e. sustained) recovery of the TRY from its effective all-time lows on a NEER basis. As such, feel comfortable reiterating our bearish bias on Turkey’s capital and currency markets.
Enjoy the rest of your respective evenings,