We still believe emerging markets are in a positive upturn, which may require some acceleration in the monetary policy reaction by EM central banks with associated positive developments in exchange rates, not necessarily ultra-connected with developments at the core (Europe, Japan and the US).
Our table, below, of PMI impulses (a simple measure capturing the momentum in various purchasing managers’ indices for emerging and developed markets), makes it clear that the current uptrend in the global manufacturing cycle hasn’t been a US-centric phenomenon.
This is the concept that underpins our view of a still erratic US dollar in a non-US growth centric world, marked by some improvement in the manufacturing cycle and in global commodities pricing.
One important point we have been emphasising with our clients is the fact that the rebound in the global manufacturing cycle started many months before the US elections, which suggests very little of it can be attributed to new US economic policy.
The global commodities price surge cannot be disassociated from the credit impulse from China. With M1 (money supply) growth at 21 per cent and a 13 per cent y/y surge in the 12m cumulative total of social financing, China continues to heavily influence the general dynamics in many base commodities. This push in commodity pricing is undeniably reflected in the terms of trade of countries such as Chile, Brazil, South Africa and Australia, to name a few.
But, differently from what many EM specialists believe, this is not a “commodity-only” EM renaissance. As we mentioned above, the surge in global manufacturing may help many EM industrial economies such as Poland and Hungary in central Europe, and Korea and Taiwan in Asia.
Looking into some of the major high-yielders in EM, the story will probably remain very tied to their central banks’ ability and willingness to accept stronger currencies, as some economies attempt a rebound from significantly negative output gaps.
The Russia macro story, as highlighted in our reports for the past many months, remains positive. This is, in our view, the most effective central bank in all EM. Discussing efficient inflation targeting in an economy such as Russia’s, so influenced by oil prices and still struggling with monetary policy transmission mechanisms, was considered a total waste of time five or six years ago.
The CBR’s very orthodox monetary policy strategy has proved the markets wrong. But the government has signalled rising concern with over-appreciation of the rouble. We believe the time for gradual interest rate cuts has come. It will be gradual, predictable and very smooth, which may continue to engineer pretty high real rates. So, barring another aggressive leg down in oil prices, government concerns with the value of the rouble may not be diluted in the medium term.
The other high-yielder in the CEEMEA region is the South African rand. This is a currency that could easily appreciate further (without any objection from economic policymakers) should the positive cycle in metal and mining commodities extend further. The terms of trade story remains strong, with the 12-month cumulative trade balance significantly overperforming last year’s results.
Unfortunately, dark political clouds are closing on South Africa once again, as infighting between the finance minister and the president gathers pace. In the event of the dismissal of key individuals in the economic team, we believe the patience of rating agencies may finally come to a sudden finish. Recently, the markets have correctly recalibrated the risk premium in the rand, as politics takes hold of the price action once again.
In the Turkish lira, the CBT has managed to engineer further stability via tightening of monetary conditions. A key issue is economic growth going further, which justifies the large expansionist fiscal impulse the country is seeing now. So, the conundrum of financial stability versus short-term economic relief does not make us very confident on the continuation of this super tight policy beyond the referendum on April 16.
In Brazil, the 18-month rates rally has reached a potential exhaustion point, as the curve now prices more than 300 basis points of cuts to the Selic benchmark rate. The political background is still shaky and, unlike Russia, Brazil does not seem to be on track for a more decisive growth rebound. With a one-year real rate at 5.3 per cent using realised inflation and 5.4 per cent using market-implied inflation expectations, the continuation of the Brazil honeymoon hinges on the ability of the government of Michel Temer to show further structural changes to investors. Passing the pension reform (even if somewhat diluted) is a key condition, given the still weak macro dynamics.
In Mexico, the peso continues to trade under the influence of strong inflows by real money managers. This, according to our EM flows monitor, is one of the largest real money positions at the moment. It is not only about diluted expectations of a more abrasive approach in global trade. It is also pure fact that the Mexican government has accelerated its reaction function on both fronts, fiscal (more restrictive measures), and monetary policy (via outright policy hikes).
Luis Costa is head of CEEMEA FX strategy at Citi