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EM Strategy Summary - 23 June 2017

Core Content

This document outlines the EM Strategy team's weekly market analysis and trade recommendations for the emerging markets (EM) sector, focusing on key themes in Asia, CEEMEA, and Latam. The team, composed of analysts from BNP Paribas and Turk Ekonomi Bank, adopts a more defensive stance across several markets due to rising US real rates and falling breakeven inflation expectations.

Main Themes

China: Pausing to Reload

• Market Conditions: 3m SHIBOR, bonds, and swap rates have continued to decline, while the repo market shows signs of re-leveraging.
• Analysis: The PBoC is not reversing its deleveraging agenda but is instead pausing to reduce pressure on the economy from higher funding costs.
• Recommendations:
  • Continue to recommend paying 1y5y steepeners.
  • Hold long USDTWD via 1m topside risk-reversals.
  • Maintain USDINR range-option structure (short 64/66 straddle to finance 66.10 USD put).
  • Retain short USDCNY NDF position.

Asia: Closing All 'Risk-On' Trades, Retain Hedges

• Market Conditions: Rising US real rates and falling CNH have increased risks for EMFX.
• Analysis: A large sell-off is not the core view, but risks have risen, prompting the team to close all 'risk-on' trades.
• Recommendations:
  • Close short SGD vs INR and short USDPHP.
  • Hold long USDTWD topside risk-reversals and USDINR range-option.

CEEMEA: Stress Test During Low Inflation

• Market Conditions: Inflation expectations have fallen due to weak commodity prices, favoring high-yielding countries with inflation above target.
• Analysis: The correlation between commodities and equities is expected to rise with further real rate increases, leading to a broader risk-off environment.
• Recommendations:
  • Recommend shorting ZAR vs TRY, targeting 3.88 vs 3.68.
  • Close short PLNHUF recommendation for a 1.1% profit.
  • Recommend buying 5y CDS on South Africa and Saudi Arabia due to fiscal and political risks.

Latam Strategy: Uneasy with US Real Interest Rates

• Market Conditions: US real rates have started to concern the team, with the possibility of a correction in risk assets in Q3 2017.
• Analysis: Argentina is particularly exposed due to high external vulnerability, unconsolidated fiscal situation, and political challenges.
• Recommendations:
  • Buy 5y Argentina CDS vs 5y EM CDX.
  • Continue paying 1y IBR in Colombia to benefit from positive carry and asymmetry.
  • Extend target on Brazil DI Jan19 receiver and increase allocation on Mexico TIIE receiver.

Key Information

• US Real Rates: Increased to positive territory, with the US curve flattening due to concerns over the Fed's ability to deliver inflation.
• EMFX and Fixed Income: Reacted less than expected due to the flattening curve, but the team is adopting a more defensive tone.
• China FX: RMB has depreciated against the USD, and the PBoC may allow further depreciation to manage bond yields.
• Trade Review:
  • Total P/L: 5135 kUSD.
  • Rates: 2848 kUSD.
  • FX: 1531 kUSD.
  • Options: 897 kUSD.
  • Credit: -141 kUSD.

Upcoming Events

• Asia:
  • China will release June manufacturing and services PMI on 30 June.
  • Several countries (India, Thailand, Philippines, Malaysia, Indonesia) will be on holiday on 26 June (Monday).
• CEEMEA:
  • Czech Republic central bank (CNB) will hold a policy meeting on 23 June.
  • Poland will release June inflation data on 23 June.
  • South Africa will release May PPI and credit growth data on 23 and 24 June.
  • Turkey will be closed on 26 and 27 June for Eid-ul-Fitr.
• Latam:
  • Brazil's National Monetary Council will announce the 2019 inflation target on 23 June.
  • Colombia's central bank (BanRep) is expected to cut policy rates by 50bp on 30 June.

Summary of New Recommendations

Key Insights

• Defensive Tone: The team is adopting a more defensive approach across EM markets due to the risk-off environment.
• Commodity Prices: Weakness in global commodities is putting downward pressure on inflation expectations.
• Policy Implications: The PBoC is likely to tighten liquidity in July to counteract the depreciation of the RMB.
• Market Correlation: The correlation between commodities and equities is expected to rise, creating a broader risk-off environment.