BCA-THE EMERGING MARKETS WEEKLY-100902.pdf

EMERGING MARKETS RESEARCH 2 September 2010 PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 29 THE EMERGING MARKETS WEEKLY Bounce ? The exuberant reaction to positive activity data from China and the US owed at least as much, we think, to cautious market valuation and defensive psychological positioning as to the magnitude of the surprises themselves. ? The data were consistent with the Barclays Capital view of a slow but steady recovery in the United States and a soft landing to high growth in China. But they were not strong enough to dispel fears of a more negative outcome, which will likely remain for some considerable time to come. ? We think the range-trading environment remains alive and well and that the economic and financial consequences of a two-speed global recovery are becoming a more important market theme. Macro Outlooks Emerging Asia: Window of opportunity to hike closing 7 Even as economic activity showed signs of moderating in August, we believe rising core inflation has increased policymakers bias to pre-empt inflation expectations. We believe central banks in the region will use currency appreciation to lean into imported price pressures. Next week, we expect the Bank of Korea to raise its policy rate 25bp. EMEA: Growth holding steady 9 EMEA growth appears to be steady, notwithstanding a deceleration in exports. We expect South Africa to lower rates again, following the surprise decline in inflation and GDP growth. Russia held its policy rate unchanged, with food inflation rising and the recovery deemed fragile. Latin America: Fiscal times 11 After Brazils decision to leave interest rates unchanged, pausing (ending?) its cycle, the focus shifts towards 2011 fiscal budgets. The 2010 fiscal outlook looks somewhat weaker, though it remains fairly healthy, with moderate deficits and declining debt ratios. Strategy Focus Indonesia: Defensive rate hikes 13 The recent spike in inflation has fanned concerns that Bank Indonesia may be falling behind the curve. We expect BI to hike the policy rate 50bp before the end of the year. We recommend investors reduce their positions in the front end (20 Source: CEIC, Barclays Capital Source: Indonesia Debt Management Office, Barclays Capital Fund flows into EM bond markets will likely continue to support long end Indo GBs Front end will likely underperform on inflation concerns and positioning We believe there is a low risk of offshore ceasing to buy bonds and higher credit growth Stay long the long end of the curve FX unhedged. Barclays Capital | The Emerging Markets Weekly 2 September 2010 16 STRATEGY FOCUS: MEXICO Sharpen your pencil This is a reprint of a report we issued on 1 September. We recommend that investors increase their underweight position in Mexican bonds. On a relative basis, we may find more value on the long end of the LatAm low beta curve (CO 41s, BR 41s, PE 33s, and PA 36s). Since the publication of MXN: Running out of good news, August 5, 2010, not only has there been little good news for Mexican assets but there also has been a string of bad news. The performance has been mixed, with the currency, as usual more volatile, taking the fastest and greatest hit, and CDS has joined it during the past couple of days. External bonds, especially the long end, meanwhile, have remained relatively better supported and rich on a relative basis (Figure 1). While we believe that some structural factors warrant a pattern of medium-term underlying trends of underperformance of Mexicos assets, such factors obviously do not explain the sharp moves in very little time. Clearly, the generally poor performance of Mexicos assets has been mostly driven by the large beta of Mexicos assets to US and global developments, with idiosyncratic factors exacerbating the sell-off. A string of headlines about drug-related violence stands out. Figure 1: Mexican assets performance: Who is next? Asset Current level* Beginning of the sell- off Performance* MXN 13.0615 12.5228 -4.30% BRL 1.7455 1.7522 0.38% COP 1811.91 1822.98 0.61% 5y CDS Mexico 143bp 115bp -1.29% 5y CDS Brazil 131bp 115bp -0.73% 5y CDS Colombia 137bp 120bp -0.80% MX 19s 160bp 140bp -0.89% BR 19s 159bp 158bp -0.02% CO 19s 179bp 166bp -0.63% MX 40s 212bp 173bp -6.33% BR 41s 206bp 169bp -5.92% CO 41s 234bp 194bp -6.53% Note: * As of closing September 1, 2010 mid. * Bond performance based on excess return Source: Barclays Capital In a more supportive global backdrop, we would expect Mexicos assets to underperform only gradually over time. In the near term, we would not expect CDS spreads, in particular, to trade meaningfully wider than other low betas. We think the riskier environment in which EM are operating makes some of the recent underperformance warranted, however. While our baseline scenario is for the US not to fall in a double dip and an escalation of drug-related violence from these already skyrocketing levels seems to have a small probability, neither of these risks can be fully ruled out. The Donato Guarino +1 212 412 5564 donato.guarinobarcap.com Jimena Zuniga +1 (212) 412 5361 jimena.zunigabarcap.com The peso and more recently CDS have priced in most of the bad news; however the bond remains rich Barclays Capital | The Emerging Markets Weekly 2 September 2010 17 peso and more recently CDS spreads have moved to price in these risks, in our view, perhaps somewhat excessively in the case of the former (see The Emerging Markets Weekly: Resisting market headwinds, August 26, 2010). Bonds, especially on the long end, however, appear relatively rich to us in this context. We have been underweight Mexico (BBB/Baa1) credit together with other LatAm low beta names for some time (Brazil, Panama), mostly due to the groups rich valuation. The solid fundamentals for the low betas were already priced in the prevailing spreads levels, in our view, which were trading tight compared with similar EM credits and their ratings. In addition, the large correlation among the spreads did not warrant a large differentiation in the recommendation, in our view. Save a few exceptions, notably our Colombia overweight position (see Colombia: Give me some credit, May 27, 2010), we have not called for any large performance diversification. We are starting to sharpen the pencil and recommend that investors increase their underweight positions from 9.6% to 7% versus a benchmark weight of 10.5%. We think that, given some prevailing growth and security risks, bonds could follow, to some extent, the underperformance of CDS spreads rather than expecting a recovery in the latter. While Mexico 5y CDS now trades wider than Brazil and Colombia by 13bp and 12bp, respectively, the long end of the Mexico bonds has not caught up. Moreover, the increase in the volatility of the Mexican bond asset has made the Sharpe ratio of these bonds less compelling. All this leads to an increase in the underweight position of Mexican credit. On a relative basis, we may find more value on the long end of the other LatAm low beta curves (CO 41s, BR 41s, PE 33s, and PA 36s). Figure 2: Mexico 5y CDS relative to Brazil and Colombia -80 -60 -40 -20 0 20 40 60 80 Oct-08Apr-09Oct-09Apr-10 Mexico - Brazil 5yr CDSMexico - Colombia 5yr CDS bp Source: Barclays Capital We increase our underweight position in Mexican bond in our model portfolio Barclays Capital | The Emerging Markets Weekly 2 September 2010 18 EM DASHBOARD George Christou +44 (0)20 777 31472 george.christoubarcap.com Alanna Gregory 212 412 5938 alanna.gregorybarcap.com Description Entry date Entry CurrentTargetStop P310 strikes) 22-Jun-10 280 285 310 - 3.5 Chow, Keller Long TRY vs USD (0.5) EUR (0.5) 22-Jun-10 1.74 1.72 1.65 1.81 0.78 Chow Long TRY/ short ZAR Cash 22-Jun-10 4.8 4.8 4.99 4.7 0.93 Badsha, Chow, Keller Short BRL put spread (1.90-2.05); finance: sell US 22-Jun-10 1.79 1.74 2.05 - - Melzi Sell USD/PHP 3m NDF 14-Jun-10 46.81 45.3 44.35 47.2 0.5 Redward short EUR/CLP 13-May-10666.8 633 615 665 0.61 Melzi Long UAH (6m T-bills, USD funded) 17-Mar-10 7.97 7.9 7.75 8.15 0.6 Chow 9m Ibovespa bear put spread (strikes: 50k, 60k) 15-Jan-10 70,800 67,041 50,000- 24.91 Loureiro, Melzi, Salomon 9m USD call/BRL put spread (strikes: 1.9, 2.1) 14-Jan-10 1.76 1.74 2.1 - 1.79 Loureiro, Melzi, Salomon Rates (11) Long 20 IndoGB FX unhedged 02-Sep-10 9.21% 9.21% 8.8% 9.65% 0.93 Rachapudi Rec 2Y PLN IRS 23-Aug-104.53% 4.61% 4% 4.75% 3.79 Chow Pay 2y Camara 06-Aug-104.11% 4.09% 4.8% 3.8% 0.17 Melzi. Zuniga Pay R206/4y spread 05-Aug-10-32bp -14.75bp0bp -45bp 0.49 Badsha India OIS: 2X5 flattener 28-Jul-10 68bp 63.5bp 50bp 80bp 0.82 Rachapudi 2y US-HK spread widener 12-Jul-10 15bp 6.54bp 35bp 3bp 8.04 Huang Hungary: 2s5s IRS DV01-N flattener 22-Jun-10 53bp 22bp 0bp 55bp 0.67 Chow, Keller Long TRY Mar'12s funded 50:50 EUR,USD 22-Jun-10 8.6% 7.99% 7.5% 9% 0.49 Chow, Keller Rec ILS 5Y IRS 22-Jun-10 3.8% 3.45% 3% 4% 0.82 Chow, Hewitt TWD: Sell 1y1y payer 23-Feb-10 20% 5.9% 0% 32% 0.23 Huang KRW Long 10y bond Pay 10y swap 03-Sep-09 86bp 40bp 30bp 105bp 0.15 Huang Closed trades (11) Date closed Buy Croatia 19s, Rom 15s, sell Hungary 15s 23-Aug-1030bp -10bp -50bp 70bp 02-Sep-10 Kolbe Buy Lithuania 5y CDS, sell Croatia 5y CDS 22-Jun-10 -18bp 25bp 50bp -30bp 02-Sep-10 Kolbe, Keller Long Indonesia 5y bond 05-Jul-10 7.89% 7.57% 7.4% 8.5% 02-Sep-10 Rachapudi Long NTN-F 17s 07-Dec-09 13.29% 11.23% 11% 11.37%02-Sep-10 Melzi Long RUB Jan'13s funded 45:55 EUR, USD 22-Jun-10 6.18% 6.2% 5.5% 6.6% 02-Sep-10 Chow, Pantyushin Sell basket/RUB 08-Dec-09 37.07 34.5 33 35 02-Sep-10 Chow, Vogel Sell SGDMYR cross 28-Jul-10 2.34 2.31 2.3 2.36 28-Aug-10 Redward, Rachapudi Pay ZAR 2x5 FRA 05-Aug-106.25% 6.14% 6.55%6.15% 26-Aug-10 Badsha Pay ZAR IRS 1y/1y 22-Jul-10 6.8% 6.44% 7.2% 6.65% 26-Aug-10 Badsha Romania 5s10s CDS Steepener (DV01-neutral) 30-Oct-09 -2bp 6bp 15bp -5bp 26-Aug-10 Kolbe, Keller Sell 1M JPY/KRW 08-Jul-10 13.75 13.73 12.85 14.1 26-Aug-10 Redward Note: As of 18/19 August 2010. Methodology: P more a global beta play now. 0.15 2.70 BRL Bearish Bad technicals, potential political noise ahead, higher intervention risks. 9m USD call/BRL put spread 0.17 2.05 Emerging EMEA EGP Bullish Attractive vol-adjusted carry, low beta to global drivers, lighter positioning and solid fundamentals are supportive of EGP. Long EGP via 3m T-bills (USD funded) 0.85 3.70 ILS Neutral Benign inflation and recent shekel appreciation may make BoI less tolerant to much more shekel strength, especially if global risk concerns were to pick up. 2m USD put/ILS RKO call (strike 3.79, RKO 3.69) 0.26 3.55 PLN* Neutral Better than expected Q2 GDP is positive for the currency but fiscal challenges and intervention risks remain. 0.25 3.35 RON* Neutral With a difficult political agenda this autumn and asymmetric intervention risks, we prefer to remain on the sidelines for now. 0.16 3.00 RUB Neutral With global growth momentum slowing and a less bullish outlook for oil, we see limited upside for further RUB strength in the short run. 0.35 2.95 HUF* Neutral/ bearish With no imminent reversal of Fidesz policies vis-à-vis IMF/EU negotiations, we still remain cautious on the HUF. 6m 290-310 EUR call/HUF put (tail risk trade/hedge) 0.11 2.80 TRY Bullish A robust recovery, light positioning and actively managed FX deposits suggest the TRY will outperform during sell-offs. Long TRY Mar12s/short EUR (0.5), USD (0.5), long TRY/short ZAR 0.22 2.65 CZK* Neutral Recent positive economic data suggest that the recovery is taking hold a positive for the currency. -0.26 2.10 ZAR Neutral Current aggressive reserve purchases are likely to make way for other measures to weaken the ZAR. -0.19 1.85 UAH Bullish New IMF funds are positive for Ukraine assets and will mean an additional powerful support for FX reserves positive for UAH Long UAH via 6m T-bills KZT Neutral FX intervention remains a big obstacle to appreciation. Note: *Versus EUR. Changes in tactical bias denoted in bold. The variable score is an index that ranks EM currencies according to the vol-adjusted returns, PPP valuation, carry, systemic risk, basic balance/GDP and reserves accumulated over the past 5y/GDP (5 is the best possible score). For more details on the trade recommendations, please see the EM Dashboard. Source: Barclays Capital Barclays Capital | The Emerging Markets Weekly 2 September 2010 20 EM CREDIT PORTFOLIO OAS (bp) Weights (%) Returns (%) Bonds we recommend 31-Dec 1-Sep 3mF OAD BenchmarkModel 1w ContributionsYTD Contributions Buying Selling EM Portfolio 270 302 262 7.0 100 100 -1.2-1.2 10.0 10.0 Arg, Ven, Ukr 880 956 807 6.2 12 12 Neutral-2.6-0.3 9.1 1.1 Other 190 217 191 7.1 88 88 Neutral-1.0-0.9 10.1 8.9 EM Asia 206 193 205 7.6 15 12 Under -0.9-0.1 15.8 2.3 Philippines 178 175 190 7.9 7.7 7.7 Neutral-1.0-0.1 16.2 1.2 RoP 19s, 20s Indonesia 196 165 190 7.6 6.0 5.9 Neutral-0.9-0.1 16.1 1.0 Indo 14s, 15s, 16s Vietnam 324 330 300 5.9 0.5 0.5 Neutral-1.60.0 12.7 0.1 Pakistan 681 739 500 4.8 0.3 0.6 Over 3.5 0.0 11.7 0.0 Sri Lanka 434 380 400 2.8 0.3 0.3 Neutral0.1 0.0 9.2 0.0 EMEA 235 271 248 5.9 38 44 Over -0.5-0.2 6.0 2.3 Turkey 185 243 195 7.0 13.3 15.7 Over -0.6-0.1 6.5 0.9 Turkey 25s Turkey 40s Russia 187 241 180 6.4 9.8 16.6 Over -0.7-0.1 9.2 0.9 Russia 15s,30s,28s Lebanon 331 338 295 3.8 2.7 3.1 Neutral-0.20.0 6.8 0.2 Leb 4% 17s (amort.) South Africa 160 170 180 5.5 3.0 1.8 Under 0.0 0.0 6.1 0.2 SoAf 19s,20s,22s Ukraine 1031 512 460 3.9 1.1 1.3 Neutral-0.40.0 27.4 0.3 Ukr 11s, 13s, Nafto 14s Hungary 224 376 415 4.9 4.5 2.5 Under -0.30.0 -6.0 -0.3 Hungary 15s Lithuania 347 299 390 4.4 2.6 0.7 Under -0.30.0 3.5 0.1 Bulgaria 215 276 360 3.0 0.7 0.7 Neutral0.2 0.0 -1.3 0.0 Bulgaria 15s Egypt 205 215 265 9.3 0.5 0.1 Under -0.80.0 11.2 0.1 Egypt 40s Egypt 20s Serbia continued m/m decline suggested by the below-50 print in the PMI import index. Barclays Capital | The Emerging Markets Weekly 2 September 2010 22 DATA REVIEW domestic demand has remained weak and, with the extensive fiscal adjustment, will likely drop further in the second half of 2010. Turkey: As the base effects fade out, we expect IP to continue to moderate in y/y terms, which, however, is in line with our 6.3% annual GDP forecast. Russia: Growing food prices have created an inflationary spike. Wednesday 8 September Period Prev 2 Prev 1 Latest Forecast Consensus 08:00 Czech Republic: Unemployment Rate (%) Aug 8.7 8.5 8.7 - 8.7 08:00 Hungary: Industrial Output (% y/y) Jul P 9.6 13.8 12.6 - - 08:00 Romania: Industrial Output (% y/y) Jul 3.0 4.1 4.7 4.0 - 12:00 South Africa: Manufacturing Prod. NSA (% y/y) Jul 8.6 8.1 8.8 7.1 - Egypt: CPI (% y/y) Aug 10.5 10.7 10.7 11.1 - 13:00 Hungary: Central Bank Minutes Sep-08 Czech Republic: Czech has yet to show job creation growth, although positive economic indicators imply that unemployment should begin to decline in the second half of 2010. Hungary: Industrial output growth is likely to continue