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EM Strategy Plus Summary - 10 June 2016

Core Content Overview

This report provides a comprehensive analysis of emerging market (EM) strategies, focusing on FX movements, bond yields, and credit opportunities across different regions. It highlights the impact of global monetary policy, particularly from the Fed and European central banks, and assesses the evolving dynamics between EM quasi-sovereign and sovereign bonds.

Main Themes and Key Points

1. Focus on Fed and European Politics

• The latest US payroll data and a dovish speech by Fed Chair Janet Yellen triggered a broad-based rally in both developed and emerging markets.
• Flows into EM are expected to continue as long as Chinese growth remains stable, but the UK referendum poses a risk of increased volatility.
• EM countries with strong local political narratives or those heavily reliant on portfolio flows are likely to benefit the most.

2. Global FX and Bond Yields

• G10 bond yields are at record lows, with the US 10-year yield just 25bp above its 2012 lows.
• EM bond yields have fallen but remain above the 2015 lows, reflecting the impact of currency depreciation and inflation.
• The Fed is likely to keep rates on hold in June, with uncertainty around the timing of future hikes. This environment supports continued low US yields and negative real yields.
• The correlation between EM FX and oil prices has increased in the low-oil price environment.

3. Asia: Traders' Market

• Improved confidence in China's FX regime and reduced likelihood of a Fed rate hike have led to a resurgence of 'risk-on' sentiment.
• The USD/Asia positioning index has turned slightly short after unwinding long USD positions from May.
• BNP Paribas has closed USDTHB long positions and taken profit on the short MYR vs IDR trade.
• New recommendations include entering a 5Y MYR NDIRS and maintaining a double-no-touch recommendation on USDKRW.

4. CEEMEA: Positive Outlook for EM FX

• EM FX is expected to outperform in June due to a more dovish Fed stance.
• The ZAR hit the 14.70 target and a profit was taken, but a further rally is anticipated.
• In Poland, the PLN rallied 0.8% against the EUR, and the NBP is expected to keep rates on hold.
• The report also includes new FX and credit recommendations, such as a long BRL against a basket and a short USDZAR trade.

5. Latin America: Mixed Performance

• The BRL appreciated significantly due to a strong trade balance and supportive external environment.
• A long BRL strategy was recommended via NDF trade, funded by other EM currencies.
• In Mexico, the MXN benefited from EM momentum, but positions were squared until further policy changes.
• In Argentina, the government is expected to release its first official CPI print post-INDEC reforms, and a long EUR Discount bonds strategy was taken profit.
• In Brazil, the BRL is among the strongest EM currencies, with a recommendation to increase long CDS seller positions and enter a long BRL strategy.

Key Recommendations

FX Positions

• Short USDZAR: Target hit at 14.70, profit taken.
• Long BRL against a basket (CLP, EUR, AUD): New recommendation via 1-month NDF.
• Close USDTHB long: Market has unwound long USD positions.
• Take profit on short MYR vs IDR: Position unwound.
• Close USDINR short: Position expired.

Rates and Credit

• Buy Argentina 2021 (Spread over US Treasury): New trade, entry level at 443, target at 383.
• Sell 5y Brazil CDS: Position increased.
• Buy Argentina EUR Discount bonds: Take profit at 105.
• Buy Angola, Gabon, Vietnam, Turkey bonds and CDS: New credit strategy.
• Sell SECO and Saudi 5y CDS: Position closed.

Quasi-Sovereign Analysis

Key Insights

• Quasi-sovereign debt has tightened significantly versus sovereigns, with limited upside in the quasi vs sovereign trade.
• With subsidies being cut and rating agencies scrutinizing implicit support, a medium-term decompression is expected.
• The report recommends selling quasi-sovereigns and buying sovereigns in certain cases, based on the relative rating differences and z-scores.

Top Recommendations

Summary of Positions and Performance

Conclusion

The report emphasizes the importance of monitoring global monetary policy and regional economic fundamentals in shaping EM strategies. With the Fed maintaining a dovish stance and EM FX showing signs of recovery, the focus is on selective trades in FX, rates, and credit, particularly in countries with strong local stories or those that rely heavily on portfolio inflows. Quasi-sovereign debt is seen as a high-risk, high-reward area, with a clear recommendation to position for decompression in the medium term.