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EM Strategy Plus Summary - 27 June 2014

Core Content Overview

This document outlines the current investment strategy for Emerging Markets (EM), focusing on interest rates (IR), foreign exchange (FX), and credit markets. It includes key views, asset allocation recommendations, and trade reviews for various countries, with a special emphasis on India, Poland, Hungary, Mexico, and others.

Main Views and Asset Allocation

India

• The Indian budget is expected to be received positively by markets, though it may not be a game-changer.
• The budget on 10 July is anticipated to highlight fiscal responsibility and support for investment, but not trigger a significant break in the USD/INR range.
• We recommend selling 1m USDINR NDF at 60.4, targeting 59.40 and stop at 61.05.
• We also recommend buying 2m USDIDR DNT at 58.8 vs 61.80 (spot ref 60.15), which costs around 30% of pay-out.

Poland and Hungary

• Long PLNHUF is recommended, as political turmoil in Poland has reached a climax with no real market impact.
• The Hungarian central bank is expected to trim its main rate by another 10bp, increasing the spread to the PLN.
• The National Bank of Poland is unlikely to cut rates in July but may drop forward guidance, interpreted as a dovish sign.
• The FX premium in Poland is higher than in Hungary, and the long-term FX premium in Hungary is almost non-existent.
• The recommendation is to re-enter a long PLNHUF position (enter at 73.50, stop loss at 73, take profit at 76.50).

Mexico

• The TIIE curve is the steepest among EM, so a flattening strategy is recommended.
• The short-end of the curve should remain relatively anchored, as the recent 50bp rate cut by Banxico was a one-off.
• The US and Mexican economies are picking up in H2 2014, and with the El Niño effect, food prices could rise, tilting inflation risk to the upside.
• We recommend paying 2y TIIE vs receiving 5y TIIE at 120bp, targeting 75bp, with a stop-loss at 150bp. Allocation is USD5k DV01.
• Carry and carry+rolldown are +0.8bp and +0.2bp per month respectively.

Other Countries

Key Trade Reviews

• Sell 1m USDINR NDF: Target at 59.40, stop at 61.05.
• Buy 2m USDIDR DNT: 58.8 vs 61.80 (spot ref 60.15), costs around 30% of pay-out.
• 2s5s TIIE flattener: USD5k DV01, entry at 120bp, target at 75bp, stop at 150bp.
• Buy 1y Brazil BEI: Target at 6.50%, stop at 5.85%.
• Buy 2y Mexico BEI: Target at 4.19%, stop at 3.34%.
• Pay 5y CLPxCAM: Target at 100bp, stop at 50bp.
• Receive HUF 5y5y fwd: Target at 4.30%, stop at 5.75%.
• Buy 5y Indon CDS: Target at 180bp, stop at 130bp.
• Buy 2m USDZAR 10.65/11 call spread: Target at 78bp.
• Sell 30-April 2015 USD/CNH call: Strike 6.90, cost 60bp.
• Buy 6m USDBRL 2.65 European digital call: Spot ref 2.39, cost 27%.

Additional Notes

• The document emphasizes the importance of carry and rolldown in FX strategies.
• Political risk in Poland is overblown, and snap elections are unlikely.
• The current account deficit in Poland is fully funded by EU flows, and the FX premium is higher than in Hungary.
• The TIIE 5y is recommended over 10y to minimize exposure to UST 10y yield shocks.
• The VAR model indicates that the TIIE 5y response to a 100bp UST 10y shock is almost half of that of the TIIE 10y.

Conclusion

The overall strategy remains focused on flattening strategies, carry trades, and credit exposure. The market outlook is cautiously positive, with a particular emphasis on the Indian budget, Polish FX market, and Mexican inflation dynamics. Investors are advised to monitor key economic indicators and stay alert to potential tail risks.