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Summary of EM STRATEGY | GLOBAL WEEKLY (16 February 2018)

Core Content

This document provides an analysis of emerging markets (EM) and Latin America (Latam) strategies, focusing on the impact of US real interest rates on EM/Latam yields and exchange rates. It includes insights from multiple BNP Paribas branches and strategists, detailing current market conditions, recommendations, and future outlooks.

Main Themes

1. EM/Latam Premiums and US Real Interest Rates

• Key Factor: Long-term US real interest rates are the most important systemic factor for EM yield.
• Recent Movement: US long-term real rates have risen by over 50 basis points (bps) in the last six weeks.
• Transmission Mechanism: The document analyses how these rate changes affect EM/Latam and simulates paths using worst-case and base-case scenarios.
• Worst Case: A 50bp rise in US real rates could lead to a 47bp increase in EMBIG 10y blended yield over 12 months.
• Base Case: A 20bp drop in the next three months followed by a 5bp monthly rise in Q4 2018, resulting in a 40bp increase in EMBIG 10y yield.
• Long-Run Multiplier: The long-end of the US curve (in real terms) is crucial for systemic risk in EM and Latam.

2. China: Bullish Rates, Cautious FX

• Policy Shift: The PBoC and SAFE have shifted their policy stance, moving towards a more stable approach.
• Interest Rates: Expect a slow rate increase, narrowing the gap with US rates.
• FX Outlook: RMB has appreciated too quickly, and a correction is anticipated. The team recommends squaring short positions at current levels and re-establishing them near 6.50.
• Volatility: RMB volatility has increased, with a 30-day realised volatility of 5%, now on par with USDSGD.
• Strategy: Maintain a bullish stance on 5-year NDIRS and government bonds, while being cautious on FX.

3. South Africa: Return to Receivers

• Net International Investment Position (NIIP): South Africa has a positive NIIP since end-2015, indicating that locals hold more foreign assets than foreigners hold in SA.
• FX Resilience: Despite a narrowing rate differential, the ZAR has shown resilience due to the NIIP and improved C/A deficit.
• Rates Curve: The SA rates curve is expected to flatten, and asset-swap spreads (ASW) to tighten.
• Recommendation: Enter a 2y2y ZAR forward receiver at 7.56, targeting 7.00 with a stop at 7.80.

4. Brazil: Positive View Reinforced

• BRL Performance: The BRL has not fully appreciated despite global sell-offs, suggesting a break in USD- and BRL-denominated fixed income assets.
• Positioning: The team is tactically long on the DI curve, particularly in the belly (Jan20-Jan21), and is long Udibono 2019.

5. Mexico: Partial Closure of Long Position

• TIIE Curve: The team partially closed a long Jun19 UDIBonus position, indicating a shift in strategy.
• FX: The RMB has been used as a liquid hedge, and the team is short USDBRL via options and against a basket of currencies.

Key Information

Financial Channel Insights

• Real Rates Matter: Real interest rate differentials are more important than nominal ones for exchange rate movements and financial flows.
• Long-Term Rates: The Federal Reserve and IMF suggest focusing on long-term rates due to the impact of zero policy rates on sensitivity analysis.
• Term Premium: The term premium in long-term bonds plays a significant role in international correlations, especially in EM.

Market Conditions and Strategies

• Current Positions:
  • Receive ZAR 2y2y (USD10k notional, targeting 7.00, stop at 7.80).
  • Long 1m USDKRW (take profit), Long EURHUF (take profit), Sell 3m USDCNY NDF.
  • Short USDBRL via options, Long BRL against a basket (CLP, EUR, AUD).
  • Tactically long PEN, Long protection in Argentina via 5y CDS.
• EM Strategy: Remain bullish on EM rates but cautious on FX, especially the RMB.

Upcoming Events

• Asia:
  • Singapore budget (19 Feb) and CPI (23 Feb).
  • Thailand GDP (19 Feb), South Korea trade data (21 Feb), Malaysia foreign reserves (22 Feb).
• CEEMEA:
  • South Africa budget (21 Feb), CPI data (23 Feb).
  • Russia retail sales (19 Feb), Poland industrial production, retail sales, and PPI (20 Feb).
• Latam:
  • Mexico CPI (22 Feb) and monetary policy minutes (22 Feb).
  • Brazil CPI (23 Feb), with inflation expected to remain under control at ~3% y/y.

New Recommendations

Final Comments

• The current dynamics of EM and Latam are unlikely to change significantly in the coming months.
• The PBoC is unlikely to tighten policy aggressively, and the RMB is expected to correct from its recent appreciation.
• The long-end of the US curve remains a critical factor in assessing systemic risk in EM and Latam.