Emerging markets review
In our view, the macro backdrop remains complicated for emerging markets (EM); with EM unlikely to enjoy the same level of “pushed” capital into the asset class as the Federal Reserve (Fed) commences the long-signalled tapering process. Likewise, the lack of EM specific growth is unlikely to extract the same level of “pulled” capital into the asset class; aging EM business models will fail to keep pace with the multi-year technology led expansion we expect in developed markets. At the same time, the growth moderation in China is an unwelcome development, which could exert pressure on EM current accounts. Despite the complicated environment that I have just outlined, the EM complex has shown tentative signs of stability over the last two weeks.
Why? While the Delta variant continues to drag on the global recovery, we have noted a very slight moderation in the hawkish rhetoric from the Fed. As a result, the recent US Dollar (USD) rally seems to have paused for breath and equities markets have rebounded from their recent wobble; this has offered support to our asset class. Likewise, at the same time, book short squaring into the summer vacation period has also played a role in the firmer period for EM. That said, we would describe stability in EM as arithmetic or mechanical and largely a result of price action or trends outside of the EM complex.
El Salvador
El Salvador’s adoption of Bitcoin as legal tender came into force this week, which got off to a very rocky start. During the rollout, the government backed Chivo wallet couldn’t cope with user registrations and was eventually taken down. Furthermore, Bitcoin tanked by almost 20% as El Salvador commenced its purchase programme, although this selloff has recovered around half of its losses over the rest of this week. During the selloff, the President announced that El Salvador had “bought the dip” and now holds 550 Bitcoin. Moreover, political tensions continued to flare this week; the constitutional court issued a surprise ruling that will allow the President to seek re-election in 2024, even though the constitution clearly prohibits consecutive terms. The ruling will further strain relations with the International Monetary Fund (IMF), where El Salvador is seeking a $1bn package. In response to a volatile week, El Salvador hard currency bonds were close to 5 points lower.
Turkey
It was a busy week for Turkey; early in the week, inflation data for August surprised to the upside, with Consumer Price Index (CPI) coming in at 19.25% vs expectations of 18.75%; real rates have now slipped into negative territory (-25bps) for the first time since October last year. Once again, the Central Bank of Turkey (CBT) is on a collision course with the country’s President; the former has pledged to keep real rates in positive territory, while the latter is once again pushing for rate cuts to combat softening domestic data. The answer to this conundrum was provided later in the week; in an interview the Central Bank governor signalled that the focus will shift from headline CPI to core-CPI, which will allow the Central Bank to claim they still have positive real rates. The market was spooked by this development, with the Turkish Lira (TRY) selling off by almost 2% this week. In terms of the portfolio, we remain neutral when it comes to the TRY; we believe that the President is likely to continue his calls for destabalising rate cuts before the year end.
Brazil
Happy Independence Day to our readers in Brazil. It was far from a quiet national holiday, where huge demonstrations took place in support of the President. The President has mobilised the protests in an effort to kick-start his campaign ahead of next year’s elections, where he continues to lag far behind in the opinion polling. The President addressed crowds in both Brasilia and Sao Paulo where he renewed his attacks on the supreme court and cast doubt on the integrity of next year’s elections. The President was not done there, where he signed a decree to change internet regulations in an effort to stop social media companies from removing content; critics have said the move will allow the spread of disinformation ahead of the election next year. Political noise is clearly picking up, which has not gone unnoticed by Brazilian markets – the Brazilian Real (BRL) has been under pressure most of the week and is close to 2% weaker at the time of writing. In terms of the portfolio, we closed our overweight BRL last month as we noted political noise has been picking up.
Poland
Towards the end of the week, all eyes were on the National Bank of Poland (NBP) policy decision; in line with market expectations, the NBP held rates unchanged and signalled it will continue with its bond purchase programme. The accompanying Monetary Policy Committee (MPC) communication was quite dovish; while there was acknowledgement of the progress on the domestic activity front, although the committee sees this as incomplete and vulnerable to downside risks from the Delta variant. Likewise, the NBP maintained its signalling on inflation, where price pressures are still considered transitory, even though CPI reached 5.4% year on year in August. In response to the NBP, market tightening expectations were tempered, resulting in Polish zloty (PLN) selling pressure. Poland remains the outlier relative to Hungary and Czech Republic, who have both started their hiking cycles. While the NBP has been resolutely dovish, in our thinking, it is a matter of time before we see a hawkish shift; the November MPC is well worth watching for this pivot. In terms of the portfolio, while we are broadly neutral when it comes to PLN, we do believe in the coming months an overweight position relative to Czech koruna (CZK) or Hungarian Forint (HUF) could be an interesting trade.
Looking forward
Looking forward, we do not anticipate a repeat of the “taper-tantrum” last seen in mid-2013. In our view, much of the “heavy lifting” in preparation for the policy tightening trend was completed during the Q1 selloff. As such, we believe there are still selective opportunities within EM to extract alpha.
Why?
- With further fiscal stimulus entering the system at home and abroad, the foundations for the cyclical rebound are solid; this backdrop is likely to support allocations to some EM rates and currencies, particularly those with a strong beta to global trade and commodities.
- Likewise, while monetary policy has peaked in both developed and emerging economies, we look for cases of divergence within the EM; we believe that cross market opportunities exist in markets where the hiking cycle is maturing, relative to those who have barely began.
- At the same time, we remain in the camp that near-term inflation pressure is transitory; the structural headwinds that have been prevalent over the last two decades are likely to dominate. Therefore, we believe that there are selective carry prospects remaining within EM.
Portfolio construction
Considering the headwinds facing EM, we remain defensively positioned. As such, we continue to run an underweight position in local rates; within this allocation we have a selective bias, pairing conviction longs against structural shorts. Furthermore, we maintain our overweight allocation to external debt, which we believe offers deep value opportunities and protection from potential volatility spikes which would squeeze our asset class. Finally, we have selective overweight positions in EMFX, targeting currencies which have robust bottom up underpinnings and deep value.
Sources
Brazil - https://www.bcb.gov.br/en/publications
Poland - https://www.nbp.pl/homen.aspx?f=/en/onbp/mpc_docs.html
Data sourced from Bloomberg & Eurizon SLJ Capital Ltd as at 9th September 2021. ESLJ-090921-I1
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