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EM Strategy Summary: 2 July 2018

Core Content

This document outlines the current economic and currency outlook for Emerging Markets (EM) in the week of 2 July 2018, focusing on South Africa, Turkey, and Latin America (Latam). It provides analysis on balance of payments, inflation, FX positioning, and investment strategies.

Main Themes and Views

South Africa: Down, but not yet out

• Current Situation: Q1 balance of payments data showed a current account deficit of 4.8% of GDP and continued FDI outflows, highlighting structural vulnerabilities.
• Vulnerabilities: High reliance on portfolio flows, weak economic growth, and fiscal pressure.
• FX Outlook: ZAR is vulnerable to global risk sentiment and EM sell-offs. It has retraced to fair value from its overvaluation in February.
• Strategy: Buy 3-month USDZAR call spread with strikes 14.40/15.10 for 1.06% notional value, maximum payout of 3.5%.

Turkey: More Constructive on TRY

• External Debt: Repayments are easing in the coming months, and the current account deficit is seasonal.
• Inflation: Expected to rise to 15% in the next two months, which may prevent the CBRT from easing monetary policy.
• Strategy: Buy 1-month USDTRY one-touch at 4.30, costing 13% (spot reference: 4.58).

Latam FX Quarterly: FEER Model Update

• FEER Model: Indicates the BRL has the highest margin for structural appreciation due to strong external funding and FX flows.
• DTCC Positioning: All Latam currencies (except COP) are in oversold territory, suggesting potential support if global financial conditions improve.

Argentina FX & Flows

• Liabilities: Liquefying of ARS liabilities is ongoing, and capital flight has accelerated.
• Investor Sentiment: Portfolio inflows are no longer viable to finance capital flight, and a change in the trend of FX outflows is needed for a shift in strategy.

New Recommendations

Trade Review

Interest Rates

• 1y5y TRY xccy steepener starting 1m fwd: 5k USD, -309 to -252, -200, -350, +57 bp, 285
• Receive 1y1y KRW NDIRS: 10k USD, 2.20%, 2.05%, 2.05%, 2.30%, +15bp, 150
• Receive 1y1y USDCNH CCS 1y1y: 10k USD, 4.10%, 4.03%, 3.80%, 4.25%, +7bp, 70
• Receive Brazil DI Jan22sJan23s FRA (new): 10k USD, 13.92%, 12.50%, 15.50%, +72 bp, 738
• Receive Brazil DI Jan20sJan21s FRA (increase): 60k USD, 10.57%, 10.25%, -1864
• Short USDPNEN via 3m NDF: USD 10mn, 3.29%, 3.19%, 3.35%, 0.82%, 82
• Long BRL against a basket (CLP, EUR & AUD) via 1m NDF: USD 10mn, 192.74/4.018/2.6285, 168.24/4.470/2.8410, 25.00%, -13.02%, -326
• Long USDBRL OT 3.30 / Mat: 21-Nov-18: USD 2.5mn, 21.50%, 8.48%, -13.02%, -326
• Long USDBRL CS (1x2) 4.00/4.40 maturity: 08-Nov-18: USD 100mn, 0.35%, 0.88%, 0.53%, 530

FX

• Long USDSGD 3m forward: USD 10mn, 1.353, 1.356, 1.38, 1.335, 0.22%, 2.2
• Short USDPOP via 3m NDF: USD 8mn, 2869.0, 2954.4, 2725.0, 2990.0, -2.88%, -230
• Short USDPNEN via 3m NDF: USD 10mn, 3.29, 3.29, 3.19, 3.35, 0.82%, 82
• Long BRL against a basket (CLP, EUR & AUD) via 1m NDF: USD 5mn, 208.46/3.379/2.4005, 168.24/4.470/2.8410, 25.00%, -18.54%, -927

Options

• Buy 1-month USDTRY one-touch at 4.30: USD 1mn, 13.00%, 13.00%, 0.00%, 0
• Buy USDZAR 3m 1x1 call spread (14.40 / 15.10): USD 10mn, 1.06%, 1.06%, 0.00%, 0
• Buy USDINR 1m 1X2 put spread (67.5 vs 66.5): USD10 x 20mn, 0.27%, 0.13%, -0.14%, -140

Bonds/Credit

• Long Peru Soberanos 2026s unhedged: 2.0k EUR, 5.27%, 5.274%, 5.00%, -0.4 bp, -4

What's Up Next Week?

In CEEMEA

• South Africa: Manufacturing PMIs to be released on 2 July, including data from South Africa, Russia, Czech Republic, Poland, Hungary, and Turkey.
• Turkey: June headline inflation expected to rise by 1.3% m/m, pushing annual inflation to 13.9% y/y from 12.1% y/y in May.
• Elections: Official results of the presidential and parliamentary elections will be released on 5 July.

In Latam

• Brazil: June inflation expected to rise to 1.33% from 0.40% m/m due to truckers' strike. FX swaps and FRA positions are expected to perform well.
• Colombia: Non-tradable prices continue to decline, with no signs of a pickup in food prices, keeping headline inflation near the central target of 3% y/y.
• Peru: Soberanos 2026s are trading at a 25bp gap from fair value, with a target yield of 5.00%.

Key Economic Indicators

• South Africa: Current account deficit at 4.8% of GDP, FDI outflows at record highs.
• Turkey: Inflation expected to rise to 15% in the next two months, external debt repayments easing.
• Latam: BRL remains the currency with the highest margin for structural appreciation. All Latam currencies (except COP) are in oversold territory.

Summary of Strategy Recommendations

• South Africa: Buy USDZAR call spread for potential appreciation.
• Turkey: Buy USDTRY one-touch at 4.30 for potential recovery.
• Latam: Long Peru Soberanos 2026s unhedged at 5.27% YTM with a target of 5.00%.

Conclusion

The report emphasizes the continued vulnerability of South Africa's ZAR to global risk sentiment and EM sell-offs, while suggesting a more constructive outlook for the TRY due to easing external debt and inflationary pressures. In Latam, the BRL is viewed as having strong potential for appreciation, with the USDCLP still in overbought territory and the USDCOP showing positive positioning. The overall strategy suggests caution and selective buying in currencies and bonds with favorable positioning and potential for recovery.