EM initially benefitted from the FOMC decision, but softened into the weekend. One culprit was lower oil prices, as reports suggest an output deal is unlikely at the OPEC meeting this week in Algeria. However, it wasn’t just EM, as the greenback closed firmer against the majors as well. We still believe that risk and EM should do fine over the next few weeks, as the Fed set a two-month window of steady rates.
EM ended last week on a soft note. Perhaps it was the North Korean nuclear test (see below). Perhaps it was disappointment in the ECB or rising Fed tightening odds. Whatever the trigger was, EM FX weakness persisted and appears likely to carry over into this week.
Indeed, as the September 21 FOMC meeting approaches, markets are likely to get even more jittery and choppy. Just to keep things in perspective, after Friday’s drop, SPX has retraced less than 38% of the big post-Brexit bounce and so this correction in “risk” could go on for a bit longer.
In the EM equity space as measured by MSCI, Colombia (+4.1%), Hong Kong (+3.9%), and China (+3.6%) have outperformed this week, while Thailand (-4.4%), Qatar (-3.3%), and the Philippines (-2.7%) have underperformed. To put this in better context, MSCI EM rose 1.2% this week while MSCI DM fell -0.5%.
EM ended last week on a soft note, as Fed tightening expectations ratcheted up. The December Fed funds futures contract has an implied yield of 0.5%, the highest since June 2. Note that on June 3, US rates plunged after the May jobs shocker (+38k). If the hawkish Fed storyline can be maintained, then EM will have trouble getting traction. This Friday’s jobs report for August will be key, with consensus at +185k vs. +255k in July.
Reserve Bank of India Deputy Governor Patel has been named to succeed outgoing Governor Rajan; political risk is back in South Africa; the Colombian government and the FARC rebels have reached a final peace agreement; S&P cut the outlook on Mexico’s BBB+ rating from stable to negative.
EM ended last week on a soft note. Fed tightening expectations were buffeted first by hawkish Dudley comments and then by the more balanced FOMC minutes.
On net, the markets adjusted the odds for tightening by year-end a little higher from the previous week, and stand at the highest odds since the Brexit vote. Yet despite the strong jobs data in June and July, odds of a move on September 21 or November 2 are still low, with the December 14 meeting seen as the most likely for the next hike.
EM FX ended the week on a soft note, despite the weaker than expected US retail sales report. Official concern about strong exchange rates is beginning to emerge. First, it was Korea, and then on Friday it was Brazil as acting President Temer said his country needs to maintain a balanced exchange rate, neither too weak nor too strong.
We expect more pushback to emerge if the current rally is extended. Still, the global liquidity outlook for now favors EM and “risk.”
S&P upgraded Korea a notch to AA with a stable outlook, Voters passed the constitutional referendum in Thailand by a wide margin, The IMF and Egypt have reached a staff-level agreement on a 3-year $12 bln loan program, Argentina’s central bank will begin using a new overnight rate to manage monetary policy, Political uncertainty has returned to Brazil
Scratch an investor, and you will find two models. One is a fair value model, perhaps based on free-cash-flow or earnings expectations, or breakup value. The other is based on liquidity. We suspect that the latter is overwhelming the former in the emerging market equity space.
The ECB and BOJ are easing policy aggressively. The BOJ has indicated it will conduct a comprehensive review next month. The only pre-condition BOJ Governor Kuroda has indicated is that the BOJ will not do less.
EM ended last week on a firm note, despite the stronger than expected July jobs report. As we suspected, one strong US data point is not yet enough to derail the dovish Fed outlook. With the RBA and BOE cutting last week and the RBNZ expected to cut this week, the global liquidity backdrop remains supportive for EM and risk.
