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EM Strategy Summary - 3 November 2017

Core Content

This report from BNP Paribas provides an analysis of emerging market (EM) strategies and outlook for the week of 3 November 2017. It outlines the current challenges EM faces due to the evolving US monetary policy environment, highlights key currencies and strategies, and discusses the implications for various regions including Asia, CEEMEA, and Latin America (Latam).

Main Themes and Recommendations

1. EM and a More Challenging Picture

• The US policy announcements and data releases suggest a more challenging environment for EM.
• Investors are advised to shorten portfolio duration and reduce exposure to countries with weaker fundamentals and those vulnerable to negative headline risks.
• CEEMEA countries outside the CEE region are considered the most at risk in the EM world.
• Despite the challenges, EM export growth remains strong, inflation is low, and external vulnerabilities have improved since 2013, except for the Gulf region.

2. Asia FX: Take Profit on Short EUR vs INR

• The short EUR vs INR recommendation has reached the target level and is closed with a 3.5% gain.
• The INR is expected to continue outperforming EM peers, supported by positive news flow and central bank interventions.
• The EUR is expected to weaken further, and USDINR is likely to trade in a broad 64-66 range.
• The rupee has been supported by reforms and stable FX volatility.

3. Asia FX: CLEER Road Ahead

• CLEER™ model indicates that KRW, IDR, and MYR are the best currencies to own over the next 12 months.
• PHP, SGD, and RMB are expected to have the least upside.
• The model does not account for geopolitical risks, which remain a source of uncertainty.
• Improving trade growth supports KRW, TWD, THB, and MYR, while rising oil prices negatively impact the balance of payments for PHP, INR, and RMB.

4. China: Take Profit on 5y NDIRS, Buy Bonds

• The bond market's sharp sell-off may be over.
• Investors are advised to take profit on 5y NDIRS and buy 5y bonds, hedged via 5y CCS.
• The model suggests a positive outlook for the Chinese bond market.

5. CEEMEA: Burst of Dependence

• FX returns often show a normal distribution, but there can be bursts of dependence due to forced position closures.
• The current TRY drawdown is approaching a critical level, similar to past sell-offs.
• Turkey is highlighted as a country of concern due to high inflation, potential rate hikes, and the impact of the credit guarantee fund.

6. Turkey: Inflation Outlook Deteriorates Further

• Inflation forecast for the end of 2017 has been revised up to 11.2% y/y, from 9.8% previously.
• End-2018 forecast remains at 8.8% y/y.
• The chances of the CBRT tightening liquidity and increasing the repo rate to 12.25% have increased.
• The TRY drawdown poses a risk to the corporate sector due to large open FX positions.

7. Brazil DI Strategy: At the Mercy of Locals

• The recent sell-off in IR and FX is driven by technical factors rather than macroeconomic concerns.
• The team believes a rate cut is likely in the short term, with a focus on the 18m TIIE receiver.
• The DI curve suggests that yields on longer tenors may decline.

8. Argentina Monetary & Debt Monthly

• Argentina's consolidated nominal budget deficit is around 8% of GDP.
• The country's twin deficit position is the worst in Latin America.
• Reliance on hard-currency funding makes it vulnerable to global risk sentiment shifts.

Key Information

• External Funding Capacity has deteriorated for several EM countries, especially in the Gulf region.
• Turkey and South Africa are highlighted as countries of concern.
• Bahrain is seen as an opportunity due to its recent financial aid request and fiscal reforms.
• The CLEER™ model is used to forecast EM currencies, indicating that KRW, IDR, and MYR are undervalued and have potential for appreciation.
• US interest rate hikes are expected in December 2017 and three more in 2018, with uncertainty around the exact shape of tax reform and Fed appointments.
• EM trade growth is accelerating, which supports the currency outlook, although some countries like China may show weaker-than-expected trade data.
• FX volatility is generally in check, with central banks implementing smoothing operations.

Summary of Trade Positions

Summary of Options Positions

Summary of Credit Positions

Outlook for Next Week

Asia

• US President Trump's visit to Asia is expected to focus on trade and geopolitical issues.
• The Bank of Thailand and Central Bank of Malaysia and BSP are expected to keep rates on hold, with varying tones.
• Philippines CPI data is important ahead of the BSP's policy decision.
• China's trade data is expected to be weaker than consensus due to weaker exports.

CEEMEA

• Poland's monetary policy is expected to remain unchanged, with the zloty likely to weaken before rate hikes.
• Czech Republic and Hungary will release October inflation data, with expected disinflation.

Latam

• Mexico's Banxico is expected to keep the policy rate unchanged, with potential rate cuts later.
• Brazil's CPI is expected to show low inflation, supporting continued monetary easing.
• The TIIE curve is seen as favorable for receivers, with the team maintaining their 18m TIIE receiver position.

Conclusion

The EM outlook remains mixed, with some countries facing heightened risks while others offer potential opportunities. The report emphasizes the need for investors to adjust their exposure and duration in light of the more challenging US rates environment. The CLEER™ model provides a framework for assessing EM currency valuations, highlighting the KRW, IDR, and MYR as the most promising for the next 12 months.