What Has Changed in EM

  • US-China relations may be thawing
  • Malaysia fiscal policy is deteriorating
  • Turkey central bank revised its inflation forecasts up sharply
  • Political risk remains high in South Africa
  • A congressional ally of Brazil President-Elect Bolsonaro downplayed the chance of passing pension reforms anytime soon
  • The Mexico City airport fiasco has dented market sentiment
  • Fitch cut the outlook on Mexico’s BBB+ rating from stable to negative

In the EM equity space as measured by MSCI, China (+8.2%), South Africa (+7.7%), and India (+6.4%) have outperformed this week, while Mexico (-3.3%), Colombia (+0.1%), and Chile (+0.1%) have underperformed. To put this in better context, MSCI EM rose 6.3% this week while MSCI DM rose 3.0%.

In the EM local currency bond space, Indonesia (10-year yield -35 bp), Turkey (-23 bp), and South Africa (-12 bp) have outperformed this week, while Argentina (10-year yield +107 bp), Mexico (+46 bp), and Pakistan (+13 bp) have underperformed. To put this in better context, the 10-year UST yield rose 7 bp to 3.19%.

In the EM FX space, ARS (+3.4% vs. USD), TRY (+2.9% vs. USD), and ZAR (+2.0% vs. USD) have outperformed this week, while MXN (-3.1% vs. USD), RUB (-0.7% vs. USD), and PEN (-0.4% vs. USD) have underperformed. To put this in better context, MSCI EM FX rose 1.0% this week.

US-China relations may be thawing. Initial reports (later denied) suggest President Trump wants to reach a deal with President Xi at their planned meeting on the sidelines of the G20 summit at the end of this month. Reports say that Trump has asked his cabinet to begin drafting some possible terms. Cynics would say that this is an easy way to boost sentiment ahead of mid-term elections next Tuesday. Optimists would say that Trump is responding to the need to ratchet down tensions between the two largest economies.

Malaysia fiscal policy is deteriorating. In his first budget since taking office, Prime Minister Mahathir Mohamad widened its deficit target for 2018 to -3.7% of GDP vs. -2.8% under the previous government.  This news along with the ongoing 1MDB fallout may be the trigger for a downgrade. Our own model shows Malaysia’s implied rating at BBB+/Baa1/BBB+, suggesting modest downgrade risks to actual ratings of A-/A3/A-.

The political crisis in Sri Lanka has deepened. President Sirisena fired Prime Minister Wickremesinghe, appointing former strongman leader Rajapaksa. Sirisena suspended parliament, which should be choosing the Prime Minister, not the president. Reports suggest parliament will be reconvened November 7 to determine if Rajapaksa will be confirmed as premier.

Turkey central bank revised its inflation forecasts up sharply. End-2018 inflation is now seen at 23.5% vs. 13.4% previously, while end-2019 is seen at 15.2% vs. 9.3% previously and end-2020 is seen at 9.3% vs. 6.7% previously. Yet the strong lira allowed the bank to stand pat last week even though inflation is now seen remaining above target until at least 2021.

Political risk remains high in South Africa. President Ramaphosa is likely to take disciplinary action against Home Affairs (and former Finance) Minister Gigaba for lying under oath. Elsewhere, Ramaphosa fired Tom Moyane, the head of the tax agency SARS due to “the reckless mismanagement which characterized” his tenure.

A congressional ally of Brazil President-Elect Bolsonaro downplayed the chance of passing pension reforms anytime soon. Indeed, Sergio Olimpio Gomes added that as proposal stands, it would not pass and that he would vote against it. Bolsonaro said this week that he wants to pass parts of the pension reform this year. These latest developments support our view that markets have gotten too bulled up about Bolsonaro.

The Mexico City airport fiasco has dented market sentiment. President-elect AMLO’s decision to cancel the airport project calls into question the rule of law and contracts in Mexico. The “public consultation” really wasn’t a valid referendum. Only 1 mln people “voted” out of a nation of 90 mln eligible voters, so it’s hard to say how this should be binding.

Fitch cut the outlook on Mexico’s BBB+ rating from stable to negative. The agency cited policy uncertainty stemming from the recent decision by president-elect AMLO to cancel the Mexico City airport project. Fitch added that “While Fitch expects the incoming administration to continue to embrace the core aspects of the macro policy framework – budget discipline and the autonomy of the Banco de Mexico, downside risks related to the incoming administration’s fiscal stance persist.”