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EM Strategy Summary - 28 July 2017

Core Content Overview

This report provides an analysis of Emerging Markets (EM) and Latin America (Latam) investment strategies, highlighting key themes and trade recommendations across various regions. The focus is on bond demand and supply dynamics in China, the potential for a rupee break lower in India, the resilience of the Qatari banking system, and the outlook for EM and Latam portfolio flows. It also outlines current trade positions and upcoming market events.

Main Themes and Key Points

1. Risk Appetite Remains Robust

• The global appetite for risk has improved, extending to the commodity complex.
• Speculative short positions in commodities are being squeezed, pushing inflation breakeven rates higher.
• EM portfolio flows are expected to remain positive in Q3 2017 unless risk premiums fall to extremely low levels.

2. China: Bond Market Dynamics

• Bond Demand: Commercial banks are the largest investors in government bonds (CGBs) and policy bank financial bonds.
• Non-Government Bond Supply: Collapsed in H1 2017 due to lack of demand from banks.
• Policy Impact: The PBoC injected liquidity in June to improve sentiment, leading to a revival in net issuance expected in H2.
• Investor Behavior: Funds and securities have been key in NCD and credit bond markets, but commercial banks are gradually moving assets back onto their balance sheets.
• Supply Trends: Net issuance of policy bank financial bonds and municipal bonds has dropped by over 50%, while credit bonds have seen an 110% decline.
• FX Position: The team remains short USDCNY and received in CNH CCS, with the market converging to their revised targets.

3. India: Rupee Range Under Pressure

• USDINR has been range-bound between 64-65 for a considerable period.
• The market is convinced the rupee will remain in this range, with implied volatility at a 10-year low.
• The RBI has been intervening persistently to support the rupee, which has led to a shift in strategy from short-vol to buying USD puts.
• The team modifies their trade recommendation to include a directional strategy of buying USD puts, increasing downside exposure.

4. GCC Credit: Qatari Banking System Remains Robust

• Sanctions have impacted the Qatari banking system through reduced regional interbank lending.
• Authorities have responded with liquidity injections, maintaining the system's resilience.
• Future risks are expected to be slow and manageable, suggesting shorting or underweighting Qatari credit is expensive.

5. Latam: Regional Outlook

• Brazil: The BCB expects to maintain the current easing pace, supporting DI receivers. The team has increased their bullish BRL positioning through an option strategy.
• Colombia: Divergence between energy prices and the peso is widening, making a tactical long position attractive. The central bank is likely to move closer to the end of its rate-cutting cycle.

6. EM Strategy Team Trade Review

• Interest Rates: The team has adjusted several trades, including a flattener in Poland, a steepener in Mexico, and a DI receiver in Brazil.
• FX: Key trades include shorting USDCOP via NDF, selling USDCNY NDF, and long BRL against a basket of currencies.
• Options: New recommendations include buying a 3m USDINR put and a USDZAR call spread.
• Credit: The team has closed a short position on Saudi 5y CDS and switched from Poland to Hungary credit positions.

Key Trade Recommendations

Upcoming Market Events

Asia

• Australia & India: Central bank meetings on 1 August and 2 August.
  • Australia likely to keep rates on hold.
  • RBI may cut rates, but not guaranteed due to past deviations from market consensus.
• Data Releases:
  • China's official PMI for July (31 July)
  • China's unofficial Caixin PMI and South Korea's trade balance (1 August)
  • CPI data for South Korea, Thailand, Indonesia, and Philippines (1 August and 4 August)

CEEMEA

• Czech Republic: Central bank policy meeting on 3 August.
  • Market expects a 25bp hike, but the CNB is likely to keep policy on hold.
• Poland: Preliminary CPI data for July (31 July)
  • Expected slight rise to 1.6% y/y.
• Turkey: Quarterly inflation report and July inflation data (1 August and 3 August)
  • Likely to revise inflation forecast slightly upwards.

Latam

• Brazil: Industrial production data (1 August)
  • Expected to fall in June, pushing YoY change into negative territory.
• Colombia: Monetary policy minutes and CPI data (4 August and 5 August)
  • Market will look for central bank guidance as it nears the end of its rate-cutting cycle.

Summary of Investment Strategy

• The team is maintaining a bullish stance on BRL through various strategies, including a one-touch trade at 2.90.
• A tactical long position on COP is suggested due to divergence between energy prices and the peso.
• The team is shorting USDCOP and USDCNY via NDFs, while receiving in CNH CCS.
• In China, non-government bond issuance is expected to revive in H2, and policy bank financial bonds are recommended for purchase.
• In India, the team is increasing downside exposure with a directional USD put strategy.
• The Qatari credit market is considered robust, with shorting or underweighting seen as expensive.
• The EM flows model suggests positive flows in Q3 2017, contingent on risk premiums not falling to extreme levels.