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Summary of EM Strategy | Global Weekly - 12 January 2018

Core Content

This document provides an overview of the Emerging Markets (EM) strategy for the beginning of 2018, highlighting the current state of global and regional markets, policy shifts, and investment recommendations. The analysis is conducted by a team of strategists from BNP Paribas and its affiliates, with a focus on FX, interest rates, and credit markets.

Main Themes and Key Points

Global Outlook

• Strong Global Growth and Low G4 Interest Rates: The first four months of 2018 are expected to see continued strong global growth and low G4 interest rates, which should support EM fixed income and equities.
• QE Diminishing: As QE tapers, EM markets may face challenges later in the year due to reduced liquidity inflows and higher valuations.
• May as a Problematic Month: May is traditionally a challenging month for EM markets, with potential trade-related headlines and rising inflation expectations.

EM Performance

• Strong Start to 2018: EM equities are up 3.5%, EM FX is up 1.5% vs USD, and EM credit is tighter by 10bp.
• Commodity Prices: A rise in commodity prices has benefited EM countries, particularly oil exporters, but some countries like South Africa have seen a slight decline due to local issues.
• China's Role: China's economic growth remains a key focus, with the Belt and Road Initiative and poverty reduction as top priorities. The country is expected to maintain growth in the 6.0-6.5% range.

Regional Insights

RMB Policy Shift

• The PBoC removed the counter-cyclical factor from the USDCNY fix, signaling a move towards normalizing the RMB FX market.
• Cross-border RMB flows are being eased, supporting the RMB's internationalization.
• The RMB may soften against the CFETS basket and USDCNY is expected to remain closely correlated with the USD index.

South Africa

• The ZAR has had its longest and largest rally since 2016, but rate spreads are narrowing.
• The risk of a currency reversal is rising, with a recommendation for a 1-month USDZAR call spread (12.70/13.20).
• Despite political developments, South Africa continues to face economic difficulties.

CEEMEA Credit Outlook

• CEEMEA countries saw more rating downgrades than upgrades in 2017, and this trend is expected to continue in 2018.
• Potential downgrades include South Africa and Oman, while upgrades are likely in Eastern Europe due to robust growth and declining debt-to-GDP ratios.

Latam FX Quarterly

• The BRL is expected to appreciate the most, with MXN, CLP, and PEN also showing potential for appreciation.
• The ARS is expected to depreciate the most, according to the updated FX valuation model.

Argentina

• The carry of the ARS remains high, but inflation premium is rising, making structural fixed income positions risky.

Brazil

• Local macro hedge funds have increased bullish allocations in Brazilian risk assets.
• A DI Jan-23 receiver was closed for a profit of 36bp, with a core position maintained in the belly of the curve.

New Recommendations

Trade Review

What's Up Next Week

Asia

• Policy Meetings: Bank Indonesia and the Bank of Korea are expected to keep policy on hold.
• Data Releases: Indonesia and India will release December trade figures, with expectations of a weaker import growth and a widened trade balance for Indonesia.
• China Data: Q4 GDP, December retail sales, and industrial production will be released, with recent data showing upside surprises.

CEEMEA

• Poland: Inflation data will be released, with expectations of confirming the preliminary print of 2.0% y/y.
• South Africa: The central bank's first MPC meeting of the year is expected to keep the policy rate unchanged, but rate cut expectations are rising.
• Turkey: The CBRT is expected to leave rates unchanged, with a possible rate cut later in the year due to easing inflation pressure.

Latam

• Brazil: The monthly economic activity index for November will be released, with expectations of continued growth.
• Mexico: Focus remains on NAFTA negotiations, with the peso's fair value expected to lie below the 19.00 handle.
• Currency Strategy: The team continues to prefer real rates (UDIBonos) for bullish allocations, using the peso as a hedge.

Conclusion

The EM strategy team remains cautiously optimistic for the early part of 2018, supported by strong global growth and low interest rates. However, the outlook becomes more complex as QE tapers and inflation expectations rise. The team recommends focusing on specific FX and rate strategies while keeping a close watch on regional developments and seasonal trends.