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EM Strategy Weekly Summary - 10 February 2017

Core Content Overview

This document provides a comprehensive analysis and strategic recommendations for Emerging Market (EM) credit and FX investors, focusing on the impact of rising rates and USD strength on EM sovereign credit, and highlighting the advantages of EM corporates as a diversification opportunity. It also outlines key market themes and upcoming data releases for EM regions.

Main Points and Recommendations

EM Corporates as a Diversification Opportunity

• Lower Duration and Maturity: EM corporates have shorter duration and maturity than EM sovereigns, making them less sensitive to rate spikes.
• Similar Ratings: Both corporates and sovereigns have similar credit ratings (BBB-), with no significant drop in credit quality.
• Yield and Spread Advantages: Corporates offer slightly lower yields (c.50bp) and spreads (c.40bp) than sovereigns.
• Performance in Rate Spikes: EM corporates historically show lower rate sensitivity and better performance during yield spikes compared to sovereigns.
• Country Exposure: EM corporates include significant exposure to China and India, which are not as prominent in sovereign portfolios.
• Risk Considerations: Higher idiosyncratic risk and lower liquidity mean more credit analysis is required for corporate investments.

Strategic Recommendations

FX

• Sell SGD vs CNH: Recommend selling 3m SGDCNH outright at 4.891 with a target of 4.70 and a stop loss at 5.00. The cross has a positive carry of +5%.
• Pay 1y1y RUB XCCY: Recommend paying 1y1y RUB forwards at 7.23, aiming to collect positive carry of 15bp per month. This is more liquid than 6m6m RUB forwards.

Credit

• Switch from Saudi Arabia to Qatar: Suggest switching from Saudi Arabia $'46s to Qatar $'46s, with a P/L of +3bp.

Key Themes of the Week

Asia

• RMB Appreciation Potential: Due to capital outflow restrictions and a stalled USD uptrend, the RMB may appreciate.
• China Data Releases: China will release December inflation data, and India will release CPI data. Both are expected to show moderate inflation trends.
• Trade Balance Watch: India's trade balance will be closely monitored for its response to rising oil prices.

CEEMEA

• Inflation Trends: Poland, Hungary, and South Africa are expected to show inflation data, with Poland likely to rise from 0.8% to 1.8% y/y.
• Monetary Policy Outlook: The Central Bank of Chile is expected to remain on hold, which could benefit CLPxCAM payer positions.

Latin America

• Brazil: The release of January external accounts is expected to show a strong trade balance and foreign direct investment, supporting BRL appreciation. There is also concern over USD 7.0bn FX swaps maturing in March 2017.
• Chile: The Central Bank of Chile is likely to maintain its current monetary policy stance, supporting the 3y and 5y CLPxCAM payer positions.

Market Analysis and Data

EM FX Carry-to-Volatility

• CNH Leadership: The CNH is the highest-yielding Asian currency and leads EM FX carry-to-volatility league tables.
• SGDCNH Correlation: SGDCNH is well correlated with the full CFETS basket, making it a viable tool to strip dollar sensitivity from long RMB exposures.

EM Credit Metrics

• Defaults Comparison: EM corporates have higher default rates than sovereigns, but lower than US HY defaults. Defaults are more sensitive to global growth crunches than rate spikes.
• Rating Splits: The EM corporate universe is nearly evenly split between investment-grade (IG) and high yield (HY) rated entities, with financials comprising the largest sector (c.40%).

Upcoming Data Releases

• Asia: China's December inflation data (Tuesday), India's CPI data (Monday), and trade balance (coming days).
• CEEMEA: Poland's January CPI (Monday), Hungary's CPI (Tuesday), South Africa's inflation (Wednesday), and Q4 2016 GDP data (Tuesday).
• Latam: Brazil's January external accounts (Friday), Chile's monetary policy meeting (Tuesday).

Conclusion

EM corporates offer a compelling diversification strategy for EM credit investors due to their lower duration, similar ratings, and better risk-adjusted returns compared to sovereigns. However, they require more in-depth credit analysis. Strategic FX and credit trades are recommended to capitalize on the current market dynamics and anticipated trends.