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EM Strategy Plus Summary - 30 September 2016

Core Content

This document outlines the Emerging Markets (EM) strategy for the week of 30 September 2016, focusing on interest rate derivatives (IRD), foreign exchange (FX), and credit instruments. It provides insights into market positioning, trade recommendations, and macroeconomic outlooks for various regions, including Asia, Turkey, Brazil, and others.

Main Points

Asia: IDR Bonds

• IDR (Investor Domestic Currency) bonds have had a strong performance due to yield compression and carry.
• Bond yields at the long end are finding a floor, with carry becoming the main driver of returns.
• Onshore liquidity conditions and supply/demand dynamics are less supportive.
• The strategy shifts to a neutral duration stance on IDR bonds.
• The long 20y FR72 position is closed at 7.36%, with a profit of 480k USD.

Asia: Close 5y CNY NDIRS

• The PBoC is unlikely to ease policy in Q4 due to improving economic data and policy concerns about the property bubble.
• The 5y CNY NDIRS receiver position is closed at 2.82%, with a loss of 20k USD.

Asian FX Positioning

• INR and IDR remain the most sought-after currencies in Asia.
• IDR positioning is approaching extreme levels.
• Investors are modestly long USDCNH.
• A clear break of 6.70 CNY/USD may lead to increased USD length.
• PHP is the most reviled currency, likely due to political developments.

Turkey: After the Downgrade

• Moody's downgraded Turkey's long-term foreign currency rating.
• Despite this, Treasury auctions attracted strong demand.
• Inflation is expected to slow, leading to cautious rate cuts by the central bank.
• 10y bonds offer value, and the strategy is to continue with the current position.

Brazil: IR/DI Strategy

• The strategy is shifting to curve playing and flattening the DI curve.
• The risk premium for Brazil is expected to decrease, supported by low G3 real rates.
• A flattening trade is recommended between DI Jan-19 and DI Jan-23, with a profit of 145k USD.

Latin America: Market Outlook

• In Brazil, industrial production and IPCA survey are key indicators.
• Inflation is expected to slow further.
• The strategy is to open a flattening trade in Brazil DI Jan-19sJan-23s.

Mexico: Peso Positioning

• The peso is considered oversold, despite structural challenges.
• The strategy remains in USDMXN via digital puts with a strike at USD 18, maturing in February 2017.
• September CPI inflation is expected to rise slightly.

Key Information

Trade Recommendations

FX Positioning Highlights

• INR and IDR: Most sought-after currencies in Asia.
• IDR: Positioning is approaching extremes.
• USDCNH: Investors are modestly long.
• PHP: Most reviled currency in Asia, likely due to political developments.

Regional Outlook

Asia

• Inflows into EM bond funds surged in Q3 2017.
• Carry-seeking inflows into high-yielding assets may persist.
• Liquidity outlook depends on the success of the tax amnesty repatriation and FX conversion.

Turkey

• Moody's downgraded Turkey's long-term foreign currency rating.
• Inflation is expected to slow, leading to rate cuts.
• 10y bonds offer value.

Brazil

• Strategy shifts to curve playing and flattening.
• Lower risk premium and low G3 real rates support the long end of the curve.
• Flattening trade recommended between DI Jan-19 and DI Jan-23.

Mexico

• Peso is considered oversold.
• Strategy remains in USDMXN via digital puts with a strike at USD 18.
• September CPI inflation is expected to rise slightly.

Conclusion

The EM Strategy team is turning neutral on IDR duration due to liquidity tightening and weaker supply-demand outlook. While IDR bonds have outperformed, returns are expected to shift to carry as long-end yields stabilize. The strategy recommends closing some positions and re-engaging at better levels. FX positioning is divergent, with IDR and INR being the most sought-after, while PHP is under pressure. In Brazil, the focus is on flattening the curve, and in Mexico, the strategy remains in USDMXN. The document also highlights the importance of upcoming economic data and central bank decisions in shaping the market outlook.