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EM Strategy Plus Summary - 15 April 2016

Core Content

Emerging markets (EM) continue to be supported by the dovish stance of G7 central banks and Chinese economic stabilization. The recent strengthening of oil prices and positive Chinese data have further boosted EM assets. Looking ahead, the eurozone is expected to have a large negative net supply of government bonds, which should support EM assets. However, the main short-term risk is the outcome of the OPEC meeting in Doha, which may not lead to a sufficient production freeze to re-balance the oil market.

Main Short-Term Risks

• OPEC Meeting in Doha: There is no guarantee that the meeting will result in a production freeze, and even if it does, it may not be enough to reverse the global oil surplus. This could lead to a negative surprise for EMs.
• China's Political Uncertainty: Political uncertainty ahead of the May presidential election could affect EM flows, though current data suggest stabilization.

Key Themes of the Week

• EM Inflows Are Here to Stay: Based on the analysis of EM flows from IIF, EM inflows have been strong and are expected to continue. The impulse-response approach shows that US monetary policy expectations have been a key driver of these flows.
• Cyclical Component of Flows: EM flows exhibit a cyclical pattern with an average duration of 10 months for inflows and 3.5 months for outflows. The recent inflow cycle in March 2016 is expected to extend into the future.
• Positive Outlook for April: EMs typically perform well in April, and the positive backdrop of G7 policies and Chinese data supports this trend.

Regional Highlights

Asia

• Buy 1m USDPHP: Despite political uncertainty ahead of the May election, the market's favored candidate is losing the lead. The recommendation is to buy 1m USDPHP with an entry level of 46.30, a target of 47.00, and a stop at 45.80.
• FX Positioning: Investors are marginally short USDAsia, with the exception of USDCNH and USDTWD. Short USD positions against PHP and IDR are starting to look stretched.

CEEMEA

• Turkey: The new central bank governor from within the MPC has reduced tail risks. The MPC meeting on 20 April is expected to result in a 50bp cut to the upper bound of the interest rate corridor, in line with market expectations. Political developments, including potential changes to legal immunity for MPs, may affect the market.
• Hungary: Hungary issued a 3y CNH Dim Sum bond at 6.25%, offering a pick-up of 60bp in USD terms. We expect Hungary to be upgraded to investment grade later this year, but the upside for USD bonds is limited.

Latam

• Brazil: Markets are closely watching the outcome of the impeachment vote. A potential new government could lead to a more positive fiscal outlook, which may support the BRL and reduce CDS spreads. However, the BCB unwound USD 24.6bn in swap contracts, limiting the rise in BRL.
• Mexico: The central bank transferred a portion of its surplus to the ministry of finance to support Pemex. This is a positive sign for the MXN, which has underperformed against peers.
• Argentina: A favorable ruling in the US appeals court allows Argentina to issue up to USD 15bn in sovereign bonds, which could support the PEN.

New Recommendations

Conclusions and Implications

• EM inflows are expected to continue, supported by stable US monetary policy expectations and a positive global environment.
• The main risks to this scenario are the outcome of the Doha meeting and any negative surprises from China.
• The study suggests that steady inflows have a more positive impact on EM risk premium than sudden changes, due to the cyclical and momentum effects of flows.
• The EM Strategy team maintains a positive outlook for EM assets, with the expectation that the worst is over.