As our Olympic & Paralympic Games series continues, Alan Wilson turns to Brazil, Mexico, Peru, Poland and Turkey to explore recent macroeconomic and market events.
As we negotiate the summer market lull, with many market participants enjoying their well-deserved vacations, the struggle continues for emerging markets. It remains a complicated period for our asset class as it is buffeted by combination of factors; the debate over peak global growth, worries over the China RRR cut, ongoing growth divergence between Developed Markets (DM) and Emerging Markets (EM), and an increasingly hawkish Federal Reserve. Over the last week, the soggy price action we have seen has been at least partly a result of the latter, with the EM ping-ponged by a string of high-profile data releases in the United States and a number of hawkish signals emanating from the Federal Reserve. At the same time, market participants have been faced with a number of EM specific event risks over the last week, which has further contributed to the muted price action in the asset class. That said, while the backdrop does indeed remain challenging for EM, there is still no sign of the dreaded “taper tantrum”. As noted in recent E.&.G.L.E-i blogs, the prospect of a disorderly emerging market selloff remains low in our view; following the volatility seen in Q1, most emerging market participants are already in a defensive posture.
Poland hit the headlines in the early stages of the week, as the ruling nationalist coalition collapsed; the Prime Minister fired his deputy, who is the leader of a smaller coalition partner party. The dispute was focused on the controversial media law which has raised tensions with European neighbours and the United States. The bill, if successfully passed, would block companies outside the European Economic Area from owning a majority stake in Polish media companies. Critics have argued that this bill is aimed at the popular TVN broadcaster, owned by Discovery of the US, which often savages the government via its independent news coverage. Thousands of protesters took to the streets over recent days to demonstrate against the bill, complaining it jeopardises press freedom. The Polish Lower House voted in favour of the bill on Wednesday evening, where it now moves to the senate. While the reaction in Polish assets has been muted, we believe that political tensions are likely to continue to rise in the region; the probability of early elections has increased sharply following the collapse of the coalition. As such, from a portfolio perspective, we continue with a mild government bond underweight.
Focus was also on the Central Bank of Brazil as it published its August policy meeting minutes. The hawkish set of minutes reinforced the central bank’s commitment to the inflation fight, signalling that it is planning another 100bp hike at the September meeting. Likewise, the minutes implied that the pace of rate hikes could be increased even further; “the Committee understands that, at this moment, the strategy of a quicker monetary adjustment is the most appropriate to guarantee the anchoring of inflation expectations”. In the aftermath of the hawkish surprise, the BRL was very well bid; we continue to favour the currency which is likely to be underpinned by the ongoing hiking cycle. That said, it is worth noting that political risks to this outlook are rising. This week, Brazil’s lower house rejected President Bolsonaro’s bid to change the country’s voting system, following his claims that next year’s election could be stolen from him. The president’s proposal would require a paper printout of each vote electronically cast. As a constitutional amendment, it needed backing by 308 of the 513 deputies; the government received just 229 votes. While the constitutional amendment will be abandoned for now, we expect political tensions to escalate over the coming months in light of the president’s low approval rating.
Later in the week, the Central Bank of Turkey (CBT) left rates unchanged at 19% during its meeting for August. The announcement was warmly welcomed by market participants who had feared a surprise rate cut; over recent weeks President Erdogan had renewed his calls for policy easing. The accompanying statement was little changed, where the CBT reiterated that economic activity is likely to remain strong amid robust external demand. Likewise, on the inflation front, the CBT continued to flag upside risks, although the drivers are considered transitory. Finally, the forward rate guidance was unchanged, where interest rates will remain above the inflation rate. Looking forward, we continue to see risks when it comes to monetary policy in Turkey; given the unorthodox central bank policy framework and ongoing pressure from the President, risks are rising that we could yet see destabalising rate cuts before the year is out.
Likewise, the Banxico policy decision was a key event towards the end of this week. For the second consecutive meeting, rates were hiked by 25bps to 4.50%, in a split vote of 3-2, which was in line with market expectations. All eyes were on the inflation forecast revisions; in a hawkish shift, the bank now expects annual inflation for this year to reach 5.7% compared to 4.8% from the June forecasts. Likewise, the forecast convergence to the inflation target was pushed out from 3Q22 to 1Q23. While the inflation revisions were undoubtably hawkish, the accompanying statement was far more balanced. Looking forward, we are sceptical that Banxico will deliver on the sheer number of hikes priced in the strip, where 160bps of tightening is expected over the next year. Why? Firstly, given the consecutive split votes, divisions seem deep rooted on the current iteration of the board. Second, the new governor, rumoured to be the former Finance Minister, is reportedly more tolerant of transitory inflation. There are only three meetings left until he takes his seat in January. The market reaction to this week’s hike seemed to chime with this outlook, with little reaction in MXN and the rally in the government bond market.
The final talking point for the week was in Peru, where the central bank surprisingly hiked rates for the first time in five years, from 25bps to 50bps. While the bank said it still has an accommodative stance, it will pay “special” attention to inflation expectations over the coming months and may tighten even further. The situation in Peru remains ugly; while growth is slowing and inflation is accelerating, political turmoil continues to grip the country and its markets. While it is difficult enough for the hard-left President to govern in light of his razor thin majority, his cabinet appointments continue to spook markets. While assurances were offered this week by tying the central bank governor to a new term, just last month, an individual under investigation for supporting terrorism was named as Prime Minister. From a portfolio perspective, we remain bearish when it comes to Peruvian assets and remain underweight government bonds relative to the benchmark.
As noted in our E.&.G.L.E-i blogs over recent weeks, we are cautious when it comes to emerging markets. In our view, the backdrop is complicated by peaking monetary policy support the United States, the spread of the coronavirus delta variant which is disproportionately hitting EM relative to DM and the prospect a moderate growth slowdown in China. While the backdrop is certainly complicated for the emerging markets, we believe that opportunities remain in our asset class. 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 emerging market rates and currencies, particularly those with a strong beta to global trade and commodities. Likewise, we look for cases of policy divergence within the EM; we believe that cross market opportunities exist in markets where hiking cycle is maturing, relative to those who have barely began. We also favour EMs which still have robust structural underpinnings despite the emergency support measures to fight the pandemic. In sum, we are on the lookout for emerging markets which have the following factors; beta to the global recovery/demand for capital goods and commodities, solid underlying fiscal dynamics, stable domestic politics, steeper curves and rewarding real yields.
Data sourced from Eurizon SLJ Capital Ltd as at 13th August 2021. ESLJ-130821-I1
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