Emerging Markets Radar (August 26, 2013)

Emerging Markets Radar (August 26, 2013)

Strengths

  • The Markit Eurozone PMI Composite Output Index signaled the largest monthly increase in business activity for over two years in August, according to the flash estimate. The PMI rose for the fifth successive month, up from 50.5 in July to 51.7, the highest since June 2011. Both manufacturing and services reported higher output in August, when manufacturing activity rose to a 26-month high, while the service sector activity rose to a 24-month high. So far, the third quarter is shaping up to be the best that the euro area has seen in terms of business growth since the spring of 2011, which should translate into rising emerging market exports.
  • Peru is now the second-highest rated country in Latin America following the raising of the nationā€™s long-term sovereign foreign currency rating by Standard & Poor. The credit rating agency raised its long-term sovereign foreign currency rating on Peru to BBB+ from BBB. The upgrade, spurred by President Ollanta Humalaā€™s sound economic policies, will likely lower the cost of capital ensuring more companies get access to capital.
  • The HSBC China August flash PMI was 50.1 versus the market expectation of 48.2. PMI above 50 indicates industrial activities are in expansion territory. When the HSBC China flash PMI is above 50, this shows the export and small and medium enterprise sectors are recovering, driven by recovery in Europe.
  • Chinaā€™s State Council issued further policy to support Chinaā€™s railway reform and construction on August 19, 2013, stressing the direction in 1) enticing social capital for railway investment; 2) setting up ā€œrailway development fundā€; 3) issuing railway bonds; 4) change railway cargo pricing to ā€œgovernment guidanceā€ from ā€œgovernment fixed pricingā€; 5) further subsidizing China Railway Corporation (CRC) in the next 2 years; and 6) accelerate construction progress to exceed original 2013 target.
  • China is to boost investments in building fiber optic and faster wireless networks to help stimulate consumption and drive economic growth. Under the plan, China will ensure half of its households to have broadband access by 2015 and 32.5 percent of cellular users will have access to 3G or other fast networks.
  • Chinaā€™s July foreign direct investment rose 24.1 percent from 20.1 percent in June, better than the estimate of 14 percent.
  • The Peopleā€™s Bank of China (PBOC), the central bank, injected Rmb72 billion this week to help lower the Shanghai Interbank Offered Rate (SHIBOR).
  • The Indonesian central bank (BI) along with the government has released policy measures to address the current account deficits and other macro-economic concerns. While these responses are sensible, the market continues to expect more definitive monetary policy responses from BI, which possibly include more rate hikes as well as continuing to let the rupiah to move towards the fundamental levels.
  • Hong Kongā€™s GDP growth was 3.3 percent for the second quarter, in line with market consensus.
  • Overseas Filipino worker remittances as of June year-to-date hit $11.8 billion, up 6.2 percent year-over-year.

Weaknesses

  • Emerging markets currencies declined significantly this week as the U.S. Federal Reserve minutes failed to provide clarity about the future of its quantitative easing program. Hardest hit were the currencies of countries with sizeable current account deficits, since the financing for such deficits is largely dependent on the U.S. money supply. In addition, some renewed strength in the Japanese yen, and the rise of U.S. Treasury yields are leading to the unwinding of foreign exchange carry trades, adding more pressure to emerging market currencies. The chart below shows the 1-, 3-, and 12-month performance of selected emerging market currencies.

account deficits weigh on Emerging Market currencies
click to enlarge

  • Mexico reported a highly disappointing GDP growth reading for the second quarter, as it also revised first-quarter growth downward. The weakness of economic activity in the first half of the year was worse than the markets anticipated, and increased speculation the central bank will lower its benchmark rate to spur growth. The data released on Tuesday, using the new base year (2008 vs. 2003), showed an annual growth rate of 1.5 percent for the second quarter, and a revision of first-quarter growth to 0.6 percent instead of the 0.8 percent reported previously. The growth decline was accentuated by severe deterioration in sectors that recently increased their weight as share of GDP, such as the construction and oil extraction industries.
  • The Philippinesā€™ stock market PCOMP Index fell 5.58 percent in the two-trading day week. Foreigners sold $153.5 million, which is 19.67 percent of 2013ā€™s net foreign outflow of $780 million.
  • China Merchant Bank announced it will sell an Rmb35 billion rights issue at HK$11.77, or a 17 percent discount to the close price on Thursday. This reminds the market that large upcoming fundraising by the mainland H-share banks will add pressure to the share prices which have already priced below net book value.
  • Hong Kongā€™s July Consumer Price Index (CPI) was 6.9 percent versus the consensus of 4.9 percent.
  • Thailand is theoretically getting into technical recession by having negative GDP growth for two consecutive quarters. The second-quarter GDP growth was 2.8 percent year-over-year (lower than the market expectation of 3.3 percent), but it was down 0.3 percent from the first quarter, while the first-quarter GDP growth was down 1.7 percent than the quarter prior. Thailand also kept the benchmark rate unchanged this week at 2.5 percent to maintain a lower Thai baht in favor of exporters.
  • Malaysiaā€™s second-quarter GDP went up 4.3 percent, lower than the market expectation of 4.7 percent due to slower investments. The current account surplus was 2.6 billion Malaysian ringgit (RM), narrower than RM8.7 billion for the first quarter. CPI was 2.0 percent in line with consensus.
  • Indonesiaā€™s second-quarter current account deficit widened to 4.4 percent of GDP, which triggered a big selloff in the stock market and its currency the rupiah.

Opportunities

  • Back in June, Bank of America Merrill Lynch published a very interesting strategy report arguing European equities outperform in an environment of rising interest rates. The report appears timelier now, following the recent positive macroeconomic readings out of Europe. In the study, empirical evidence shows there is a clear relationship between rising U.S. rates and European stocks outperforming U.S. stocks that holds over the last 40 years. Since 2000 a 1 percent fall in year-over-year returns in U.S. treasuries has coincided with a 100 basis point outperformance of European equities, with the majority of the alpha being captured in the 6- and 12-month periods after the rise in U.S. yields.

account deficits weigh on Emerging Market currencies
click to enlarge

  • No taper talk in Chile as borrowers take advantage of lower local currency financing costs. Chilean corporate financing costs in pesos are falling to the lowest in four years compared to borrowing abroad as speculation grows the central bank will cut rates for the first time since 2012. Since May, when Federal Reserve Chairman Ben S. Bernanke began talking about reducing monthly bond buying, the cost of funding in the Chilean peso versus the U.S. dollar reversed, making much more attractive for Chilean companies to issue locally. In view of the recent hostility and lack of appetite for lending in the international markets, companies have the opportunity to tap into local debt capital markets for interesting opportunities.
  • As shown in the graph below, the HSBC China flash PMI is back to expansion territory at 50.1 in August. Industrial activities improved due to the recent fiscal stimulus policies that were announced after Premier Li Keqiang showed his road map in supporting growth while undertaking reforms.

Chinas Jump in manufacturing
click to enlarge

Threats

  • Czech members of Parliament voted to dissolve the Lower House, paving the way for an early election. The move is the latest episode in a political crisis that began with the collapse of the center right coalition over a corruption scandal in June. Terms for the early election should be confirmed after discussions between the president and parliamentary parties, with the tentative date being October 25-26. The division among center right parties may offer the center left platform an opportunity to regain control of Parliament.
  • There is no denying the Fedā€™s roadmap affects the expectation of future interest rates and of term premium and, thus, will affect long-term interest rates in the U.S. and Latin America. Citi, in its Emerging Markets Economics research, identifies how a higher global interest rate environment threatens Latin America. A higher interest rate environment will lower capital inflows into the region and translate into lower credit growth. Furthermore, public sector balance sheets have improved over the past decade but remain vulnerable to lower growth and softer commodity prices. In this context, Venezuela and Argentina are the most vulnerable, followed by Peru and Brazil. Chile, Mexico, and to a lesser extent Colombia, are the least vulnerable countries to a capital market external shock.
  • Investor sentiment toward Association of Southeast Asian Nations (ASEAN) countries deteriorated after Fed tapering talk started this year. Foreign investors redeemed their investments in emerging market bonds and equities, ASEAN included, which added pressure on already weakened currencies. Particularly weak is the Indonesia rupiah which fell 5 percent against the U.S. dollar after Jakartaā€™s stock market fell 8.73 percent in the week. In an environment of rising yield and depreciating currencies, the fundamentals of the ASEAN economies are believed to be weakened temporarily, but can be re-strengthened after an adjustment to find their normality.
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