Emerging Markets Repricing, Latam, Russia and Asia
EM investors are quickly having to reassess risks to their exposure, after the US election outcome supported expectations of a potentially stronger growth trajectory fuelled by fiscal stimulus. The last week, post the US elections, was one of the worst for EM FX and fixed income assets in many months, with some of the re-pricing dynamics reminding us of the early days of the 2013 Taper Tantrum. We think that it is too early to fade the sell-off in EM fixed income as the risks of further re-pricing of the UST curve are high. We are also not encouraged by little evidence of resistance from EM central banks to weaker currencies so far. At this stage, we think that a clear shift in the trend of UST re-pricing is likely the main factor that could alter the trend in EM assets. Clarity regarding a potential protectionism turn in the US under Trump’s administration will also be important for the direction of EM assets going forward.
The last week, post US elections, was one of the worst for EM FX and fixed income assets in many months. Between the US elections (close of 8 November) and yesterday’s close, the EM sovereign dollar debt benchmark returned -4.3% while EM local currency debt returned -6.6%. This sell-off has made a significant dent in year-to-date returns, but year-to-date gains are still decently positive at +9.0% for sovereign dollar debt and +8.5% for local currency debt.
We expect asset prices to stabilize in the near term after the initial sharp sell-off, but maintain a cautious stance going forward. The expectation for higher and steeper rate curves in the US should continue to put pressure on Latam fixed income markets. We think there will be opportunities in front end rates, particularly in those countries where the scope for looser monetary policy is still in place (i.e., Brazil, Chile and Colombia). In Argentina, we recommend reduce exposure to bonds and add to GDP warrants. In terms of market drivers, the focus this week will be on the monetary policy meetings in Mexico and Chile, both on Thursday.
We recommend investors adopt a near-term defensive bias as the risk of further re-pricing of UST remains high, in our view. In Russia, we initiate a 2s7s xccy curve steepeners recommendation (target: -100bp, current: -141bp) after this slope has lagged the global steepening trend. We also take profits on our OFZ curve steepeners trade recommendation. In Turkey, 3m12m xccy flatteners remain one of our favorite near-term trading exposures. On the events front, Hungary will be in focus with the credit rating review by Fitch (Friday) and monetary policy decision (Tuesday).
Fixed income sentiment is likely to remain bearish and position unwinding will likely continue. Higher global rates and weaker EM risk sentiment are hurting both the low yielders and the high yielders. Domestic positives and policy support will be key to stabilizing sentiment in the near term. India fixed income markets are likely to be relatively insulated and Indonesia could find some support too, if policy makers step up intervention this week. The low yielders could be more vulnerable with diverging policy settings weighing on domestic sentiment. We look for opportunities to hedge our risk in India bonds by paying front end OIS and are biased to receive MYR IRS.