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EM Strategy Plus Summary - 26 August 2016

Core Content

This document provides a weekly summary of emerging market (EM) strategy recommendations and market analysis from BNP Paribas, focusing on Asia, South Africa, Turkey, and Slovenia. It outlines key positions, market sentiment, and future outlooks for various currencies and bonds.

Main Themes and Views

Asia

• IDR NDF Curve: Risk appetite is wavering, and long positioning in IDR suggests a potential correction. The strategy recommends paying USDIDR NDF points to hedge against this risk. The NDF curve currently offers historically tight risk premia with minimal negative carry.
• CNY NDIRS: CNY rates have sold off sharply due to the PBoC's liquidity injection via term repos instead of overnight. The strategy suggests fading the sell-off at current levels, with a recommendation to receive 5y CNY NDIRS at 2.76% with a target of 2.60% and a stop loss at 2.90%.

South Africa

• USDZAR Trend: USDZAR is expected to remain on a downward trend, with the current rise unlikely to exceed the 50-day moving average. A fly option strategy is recommended instead of outright short positions.
• FX Strategy: The trade involves a 2m USDZAR put fly with strikes at 14.10/13.70/13.30, costing 0.50% of notional. The strategy aims to test the continuation of the downward trend.

Turkey

• CBRT Policy: Economic activity is weakening, and the Central Bank of Turkey (CBRT) is likely to ease monetary policy further. The short end of the yield curve offers value, with the 2y benchmark bond yield at 9.0% and the 1y cross-currency swap rate at 8.88%.
• Long End Vulnerability: The long end of the curve is likely to remain immune to the global search for yield due to the risk of a rating downgrade.

Slovenia

• Eurobond Tender: Slovenia has announced a second tender for Eurobonds maturing in 2022, 2023, and 2024. As the amount outstanding decreases, Slovenia may continue to tighten its bond yields, potentially approaching levels seen in Latvia.
• Bond Valuation: Slovenia's bonds trade wide for its Baa3/A/BBB+ rating, indicating positive sentiment towards the bonds.

New Recommendations

Trade Review

• Interest Rates:
  • Receive 5y CNY NDIRS (new)
  • Receive 2y THB NDIRS vs. pay 2y US IRS
  • Receive 3y USDKRW NDS
  • Pay the belly of 1s2s5s butterfly TRY xccy
  • Buy Brazil USD rates Apr-17 offshore
  • Buy Brazil NTN-B May 21
  • Receive Colombia 5y IBR spread over US swap
• FX:
  • Buy 1x12 USDIDR NDF (new)
  • Sell 3m USDTHB fwd
  • Buy USDSGD
  • Buy PLNHUF
  • Buy USDCOP via 1m NDF
  • Sell EURPN via 1m NDF
  • Buy BRL against a basket (CLP, EUR & AUD) via 1m NDF
• Options:
  • Buy 3m dual digitals in USDJPY and USDKRW
  • Buy 3m USDINR PS
  • Buy 3m USDIDR put fly
  • Sell 1y USDCNH ATMF straddles
  • Buy 2m USDZAR put fly (new)
  • Buy 2m USDZAR put spread
  • Buy 6m USDILS call butterfly
  • Buy 1m USDBRL Digital CS
  • Buy 1y USDMXN digital put
• Credit:
  • Buy Qatar $ '26s, sell Abu Dhabi $ '26s
  • Buy Tunisia $ '25s (spread over swaps)
  • Buy Turkey EUR 21s, buy Turkey 5y CDS
  • Buy South Africa $ 22s, sell Poland $ 22s (stopped out)
  • Buy Hungary $ 21s, sell Poland $ 21s
  • Buy South Africa $ 22s, sell Croatia $ 23s (stopped out)
  • Buy Slovenia $ 22s, sell Latvia $ 21s
  • Buy Lithuania $ 21s, sell Latvia $ 21s

Key Market Events

• Jackson Hole Conference: Expected to provide guidance on the September FOMC meeting. The market currently assigns only a 30% probability to a rate hike, and the US long-term inflation breakeven is below 1.5%, suggesting a rate hike is unlikely to lead to a significant pricing in of more hikes.
• Asia: No monetary policy meetings, but the focus will be on the PBoC's liquidity decisions and the monthly PMI numbers, especially the Caixin PMI.
• South Africa: Political news and FX volatility triggered a correction, but the market does not see this as a permanent trend.
• Turkey: July tourist arrivals and trade balance data will be released, along with the August PMI and preliminary foreign trade data.
• Brazil: The monetary policy meeting on 31 August will be a key event, as well as the outcome of the final impeachment vote.
• Colombia: The monetary policy meeting on 31 August is expected to leave rates unchanged.
• Mexico: The quarterly inflation report will provide insight into inflation risks.

Market Outlook

• EM flows are driven by US dollar liquidity, which is influenced by US real rates. The strategy highlights the importance of US real rates remaining in negative territory for continued EM performance.
• The market is cautious about a correction in IDR due to increased long positioning and potential sentiment shifts.
• The PBoC's liquidity injection via term repos is seen as a way to curb leverage without triggering a sharp rise in interest rates.
• The CBRT is likely to continue easing monetary policy, especially if global risk sentiment remains supportive.
• Slovenia's bond yields may continue to tighten as Eurobond outstanding amounts fall.

Conclusion

The document outlines a cautious yet positive outlook for EM markets, emphasizing the role of US real rates and liquidity conditions. It recommends hedging strategies in IDR and CNY, and a fly option strategy in USDZAR to test the downward trend. The CBRT's likely further easing in Turkey and Slovenia's potential to tighten are also highlighted as key opportunities.