EM Strategy Weekly Summary - 17 February 2017
Core Content
This document is a weekly report from BNP Paribas on Emerging Market (EM) credit, FX, and interest rate strategies. It highlights the current state of EM credit and FX markets, forecasts for growth, inflation, and central bank policy, and provides recommendations for investors.
Main Points
EM Credit: Forecast Changes and Valuations Imply Caution
- BNP Paribas economists have revised up their forecasts for growth, inflation, and central bank policy, especially for the Fed and ECB.
- EM credit has performed very well since the US election and is in significantly rich territory compared to the rest of global credit.
- A correction in EM credit is expected due to a potential yield spike and the pricing in of a May rate hike by the US Fed.
- Investors are advised to be cautious, and to consider buying downside protection as real rates are expected to rise.
Key Themes of the Week
- Asia: Portfolio inflows are improving, and Asian central banks are reluctant to intervene, which suggests further strength for Asian currencies.
- China: Short-term interest rates are expected to remain bearish, but the PBoC will provide sufficient liquidity. Investors are advised to buy 3-month NCDs at 4.4-4.5%.
- South Africa: USDZAR has broken below 13.20, and the team is waiting for a more extreme level to roll over the call spread.
- Turkey: The middle of the curve is considered cheap, but investors are advised to stay defensive due to the expected supply of TRY 18.5bn in March.
- Latam: The team has no new trade recommendations this week. Brazil and Mexico are expected to continue their rate easing cycles.
BNP Paribas Risk Premium Model
- The risk premium model indicates a low risk premium, suggesting high investor risk appetite.
- However, this does not necessarily mean a reversal in the appreciation trend of EM/Latam risk assets, but rather a call for caution.
Key Market Forecasts
| Market |
End-2017 |
End-2018 |
| US Rates |
3.5% |
4% |
| Eurozone Rates |
1% |
1.60% |
| EURUSD |
1.02 |
1.06 |
| USDRMB |
7.06 |
7.01 |
Strategies for EM Credit Investors
- Trade the US versus EM credit divergence: Focus on blue-chip US credits, as they are mostly investment grade (IG).
- Look at EM corporates: EM corporates are expected to perform better in yield spike environments, as seen in previous years.
- Buy options: Given the low volatility, buying options to hedge against rate uncertainty is a recommended strategy, especially covering the May Fed meeting.
FX Recommendations
- Sell 3m SGDCNH outright: USD 10m notional, with a current level of 4.851.
- Long USDARS 2y NDF against short USDARS 1y NDF: USD 10mn notional, with a current level of 26,076.
- Short CLPCOP via 1m NDF: USD 5mn notional, with a current level of 4.516.
- Short CADCOP via 1m NDF: USD 7mn notional, with a current level of 2,201.
- Long BRL against a basket (CLP, EUR & AUD): USD 10mn notional, with a current level of 206.87/3.295/2.3755.
What's Up Next Week
Asia
- China's focus will be on the January CPI and industrial production data.
- South Korea's central bank is expected to keep rates on hold.
- Thailand's Q4 2016 GDP release is closely watched.
- Singapore's CPI and monetary policy meeting are important events.
CEEMEA
- South Africa's budget will be the key focus, with expectations of a conservative budget and continued rate easing.
- Poland's unemployment data will be released.
- Turkey will issue 5y fixed coupon bonds, and the consumer confidence index is expected to rebound.
Latam
- Brazil will release February mid-month CPI data, with expectations of continued rate easing.
- Mexico's policy meeting minutes and bi-weekly CPI will be scrutinized.
- Colombia's central bank is expected to keep rates on hold.
Key Market Data
Interest Rates
| Trade Description |
PV01 / Notional |
Entry Date |
Entry Level |
Current |
Target |
Stop |
P/L |
P/L kUSD |
| Pay 1Y1Y RUB XCCY |
5k USD |
10-Feb-17 |
7.23% |
7.14% |
7.30% |
7.10% |
-9 bp |
-45 |
| Receive 5Y5Y SGD IRS vs. 5Y5Y USD IRS |
10k USD |
19-Jan-17 |
0.55% |
0.35% |
0.20% |
0.70% |
+20 bp |
200 |
| INR NDOIS 2Y5Y flattener |
10k USD |
16-Jan-17 |
0.29% |
0.30% |
0.10% |
0.40% |
-1 bp |
-10 |
| Receive 1Y1Y KRW NDIRS |
10k USD |
17-Nov-16 |
1.60% |
1.58% |
1.40% |
1.70% |
+2 bp |
20 |
| Receive 5Y AUD IRS vs. pay 5Y KRW IRS |
10k USD |
04-Jan-17 |
0.96% |
0.85% |
0.60% |
1.10% |
+11 bp |
110 |
| Flattening Colombia IBR 1y-3y |
6k USD |
27-Jan-17 |
-63 |
-82 |
-90 |
-39 |
+19 bp |
148 |
| Flattening Brazil DI Jan18sJan20s |
25k USD |
13-Jan-17 |
-43 |
-39 |
-75 |
-19 |
-4 bp |
225 |
| Pay CLPxCAM 5y |
5k USD |
15-Dec-16 |
3.78% |
3.62% |
4.25% |
2.97% |
-16 bp |
-92 |
| Pay CLPxCAM 3y |
6k USD |
16-Nov-16 |
3.69% |
3.24% |
4.00% |
2.97% |
-45 bp |
-266 |
FX
| Trade Description |
Notional |
Entry Date |
Entry Level |
Current |
Target |
Stop |
P/L |
P/L kUSD |
| Sell 3m SGDCNH outright |
SGD 10m |
07-Feb-17 |
4.891 |
4.851 |
4.7 |
5 |
0.8% |
58 |
| Long USDARS 2y NDF against short USDARS 1y NDF |
USD 10mn |
20-Jan-17 |
22,000 |
26,076 |
27,500 |
17,500 |
2.55% |
255 |
| Short CLPCOP via 1m NDF |
USD 5mn |
29-Dec-16 |
4.516 |
4.516 |
4.245 |
4.696 |
0.71% |
35 |
| Short CADCOP via 1m NDF |
USD 7mn |
27-Oct-16 |
2,222 |
2,201 |
2,100 |
2,420 |
3.20% |
224 |
| Long BRL against a basket (CLP, EUR & AUD) |
USD 10mn |
07-Jun-16 |
192.74/4.018/2.6285 |
206.87/3.295/2.3755 |
25.00% |
15.00% |
18.88% |
1888 |
Options
| Trade Description |
Notional |
Entry Date |
Entry Level |
Current |
Target |
Stop |
P/L |
P/L kUSD |
| Buy at 13.25 1xUSDZAR 2m call k=13.75 sell 1.5xUSDZAR 2m call k=14.20 |
USD 10mn |
03-Feb-17 |
0.45% |
0.39% |
- |
- |
-0.06% |
-6 |
| Buy EURTRY 1m put at 4.01 and sell put at 3.90 and call at 4.15 |
EUR 10mn |
03-Feb-17 |
0.00% |
1.75% |
- |
-1.50% |
1.75% |
186 |
| Buy 3m USDJPY / USDKRW dual digital (112 / 1200) |
USD500K payout |
13-Dec-16 |
9.00% |
6.00% |
- |
- |
-3.00% |
-15 |
| Long USDMXN PS k=20.55/19.75 / exp: 19 April 2017 |
USD 25mn |
31-Jan-17 |
1.33% |
1.59% |
- |
- |
0.26% |
65 |
Credit
| Trade Description |
PV01 / Notional |
Entry Date |
Entry Level |
Current |
Target |
Stop |
P/L |
P/L kUSD |
| Switch from Saudi Arabia $'46s into Qatar $'46s |
5k USD |
01-Feb-17 |
-16 bp |
-15 bp |
-35 bp |
0 bp |
-1 bp |
-5 |
Summary of Key Market Events
- China: Buy 3-month NCDs at 4.4-4.5%.
- South Africa: Expect USDZAR to return to its trend level.
- Turkey: Middle of the curve is cheap, but stay defensive.
- EM Risk Premium Model: Advises caution due to the low risk premium.
- EM Credit Performance: Strong performance due to inflows, but caution is advised as real rates are expected to rise.
Conclusion
The report suggests that EM credit and FX are in a strong position, but with the potential for correction due to rising real rates and US Fed rate hikes. Investors are advised to be cautious and consider hedging strategies, especially in the context of uncertain timing for rate changes. The team recommends focusing on EM corporates, buying options, and monitoring key macroeconomic indicators and central bank actions.
