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EM Strategy Plus Summary - 27 May 2016

Core Content

This document provides a detailed analysis of Emerging Market (EM) strategies and market conditions leading up to the June FOMC meeting. It highlights the current state of EM assets, FX positioning, and trade recommendations, while also discussing key economic indicators and central bank actions that may influence the market.

Main Viewpoints

• EM Performance: EM assets showed weak performance in May, following a seasonal trend. Investors are likely to be cautious before the FOMC meeting, but the Fed is not expected to hike rates soon, creating potential for risky assets to rally.
• FOMC Outlook: The market now prices a 70% chance of a 25bp rate hike by late July. A weak May NFP report is anticipated, which may lead to concerns about the US economy and delay rate hikes.
• Yellen's Speech: Yellen's speech on 6 June is expected to provide market guidance but not significant policy details.
• ECB Meeting: The ECB is likely to maintain a cautious stance, balancing optimism with preparedness for shocks. A potential extension of the asset purchase programme may be necessary if core inflation remains below projections.
• Oil Prices and Real Rates: The recovery in oil prices and negative US real rates are seen as supportive for EM assets.
• FX Positioning: Asian FX positioning has seen a reduction in the largest positions, indicating a lack of firm views and low participation. Long USD positions against CNH and SGD, and short USD against INR and IDR have been reduced. Long USDTHB and short USDPHP positions have increased.
• CEEMEA Outlook: Capital outflows in Turkey and South Africa in May suggest underweight positions. Inflation in Turkey is expected to rise, and the CBRT is likely to normalize rates. In South Africa, a short USDZAR position is maintained.
• Latam Insights: The MXN has been under pressure due to its volatility, affecting bond yields. Banxico is expected to act to prevent market expectations from becoming entrenched. In Brazil, political instability is seen as a potential entry point for flatteners and CDS sell recommendations. In Argentina, BCRA has restricted Euroclearability of ARS Lebacs, signaling increased regulation.
• Trade Review: The document outlines the performance of various trades, including FX and interest rate positions, with a focus on profitability and future outlooks.

Key Information

Asian FX Positioning

• Position Reductions: The largest positions in USD/Asia have been reduced, indicating a lack of firm views and low FX market participation.
• Specific Currencies: Long USDCNH, USDSGD, and USDTWD positions have decreased, while long USDTHB and short USDPHP positions have increased.
• Market Indicators: FX positioning indicators show a shift towards caution, with moderate levels of long and short USD positions.

CEEMEA

• Turkey: CBRT reduced the upper bound of the interest rate corridor by 50bp, but liquidity constraints limit the decline in swap rates. The team recommends receiving the short end.
• South Africa: Capital outflows in May suggest underweight positions. The team maintains a short USDZAR position targeting 15.00.
• S&P Rating Review: South Africa's rating is under review, with a BBB- outlook. A downgrade is unlikely in the short term, but a December downgrade is a risk.
• Economic Forecast: A below-consensus GDP growth forecast of 0.4% for South Africa increases the risk of a rating downgrade.

Latam

• Mexico: MXN volatility is affecting local bond yields. Banxico should act to prevent self-fulfilling market expectations.
• Brazil: Political instability is influencing bond prices. The team recommends DI Jan17sJan19s flatteners and Brazil CDS sell.
• Argentina: BCRA's changes to Lebac issuance limit Euroclearability, suggesting increased regulation to curb inflows. The team does not see a favorable entry point for long USDARS positions.

Trade Summary

• Interest Rates: Positive carry from USDTRY and RUB 1y1y ccy swaps, but some positions were closed with losses.
• FX: Short USDZAR, sell MYRIDR, and buy USDTHB positions were maintained or adjusted.
• Options: Various options strategies were used, including dual digital options and call spreads.
• Credit: Recommendations included buying corporate bonds and CDS in countries like Turkey, Vietnam, and Brazil, with some positions reduced or closed.

Conclusion

The EM market is expected to see increased inflows in June due to the Fed's cautious approach and negative real rates, which make underweight positions costly. FX positioning has shifted towards risk reduction, with a focus on cautious strategies and selective long positions. The team maintains specific trade positions in various currencies and interest rates, based on economic outlook and market conditions. Political developments and central bank actions are key factors influencing EM strategies.