What Has Changed

What Has Changed in EM

1) Central bank of Chile hiked rates for the first time since late 2011
2) Chile is moving towards a new constitution
3) Fitch downgraded Brazil one notch to BBB- and kept a negative outlook
4) India started the second round of important local elections this week
5) The central bank of Egypt weakened the pound for the third time this year
6) Indonesian regulators plan to impose capital surcharges on financial institutions
7) The Bank of Korea cut its growth and inflation forecasts, but kept rates steady at 1.5%
8) The MAS adjusted the S$NEER band at its semi-annual policy meeting

In the EM equity space, China (+5.8%), Hong Kong (+2.7%), and Singapore (+1.1%) have outperformed over the last week, while Brazil (-5.4%), Colombia (-2.5%), and Indonesia (-1.5%) have underperformed.  To put this in better context, MSCI EM rose 0.7% over the past week while MSCI DM rose 0.3%.

In the EM local currency bond space, Ukraine (10-year yield -78 bp), Russia (-36 bp), and China (-15 bp) have outperformed over the last week, while Brazil (10-year yield +20 bp), Hungary (+11 bp), and Indonesia (+4 bp) have underperformed.  To put this in better context, the 10-year UST yield fell -7 bp over the past week.

In the EM FX space, ZAR (+1.9% vs. USD), KRW (+1.3 vs. USD), and SGD (+0.9% vs. USD) have outperformed over the last week, while BRL (-2.0% vs. USD), ARS (-1.5% vs. USD), and EGP (-1.3% vs. USD) have underperformed.

1) Central bank of Chile hiked rates for the first time since late 2011.  The tightening cycle started with a 25 bp move to 3.25%, as expected.  CPI rose a lower than expected 4.6% y/y in September, down from 5% in August but still above the 2-4% target range.  Taken in conjunction with the firmer peso, we that the tightening cycle will not be aggressive.

2) Chile is moving towards a new constitution.  President Michelle Bachelet got the ball rolling to replace the constitution that was drawn up under the military rule of General Pinochet.  Bachelet would like to start a “civic education” phase followed by a “dialogue with citizens” to draft the document, with the hopes of sending the proposed new constitution to congress sometime in 2017.  This was part of her campaign promise, and the initiative comes at a good time since her poll ratings are slipping.  The risk is that the process will distract the country from harder reforms including education and labour.

3) Fitch downgraded Brazil one notch to BBB- and kept a negative outlook.  This really shouldn’t come as a big surprise, as the BBB rating it had was too high.  Our own sovereign rating model now has Brazil at BB-/Ba3/BB- so downgrade risk remains very strong.  S&P has it at BB+, while Moody’s has it at Baa3 with an inexplicable stable outlook.  Markets might show some relief that Fitch didn’t cut by two notches to BB+, but we think another cut is in the cards to BB+.  We think all 3 will eventually move to sub-investment grade, but Fitch’s negative outlook suggests it will move before Moody’s does given its stable outlook.

4) India started the second round of important local elections this week.  On Monday, voters in the state of Bihar began the election process for the legislative assembly that will last for the next three weeks, with the second stage started overnight.  These elections matter because it will be an important indicator of the odds of the government coalition, led by Modi’s BJP, gaining control of the upper house. The broad government coalition, NDA, already has control over the lower house after its 2014 victory, but it’s unclear if they will be able to secure a broader victory in 2018.

5) The central bank of Egypt weakened the pound for the third time this year.  Gross foreign reserves fell $1.7 bln to $16.4 bln in September, the most in nearly four years.  Reserves are the lowest since March, and have been drained by the central bank’s efforts to prop up EGP.  The devaluation was only about 1% this time, and we think more will have to be done in the coming months.

6) Indonesian regulators plan to impose capital surcharges on financial institutions. The capital surcharge will be imposed on banks categorized as “domestic systemically important,” though the document is still in its draft stage. Although the announcement dampened the rebound in Indonesian assets, we think it’s a net positive. This is a step forward in ensuring financial stability in a country often placed together with the more fragile emerging markets.

7) The Bank of Korea cut its growth and inflation forecasts, but kept rates steady at 1.5%.  GDP is expected to grow 2.7% this year, down from 2.8% previously.  For next year, the BOK sees GDP growing 3.2% vs. 3.3% previously.  Inflation is forecast at 0.7% this year and 1.7% next year, still below the 2.5-3.5% target range.  We think downside risks will move the BOK to a more dovish stance in 2016.

8) The MAS adjusted the S$NEER band at its semi-annual policy meeting.  It “slightly” reduced the slope of the band, while keeping its policy for “modest and gradual” appreciation.  The move was less dovish than expected, helping SGD to outperform this week.  With deflation risks persisting, we think further action will be taken in 2016.