Emerging Markets
In recent travel, our clients remain focused on downside risks to today's range-bound markets. And for good reason. Uncertainty regarding Chinese reaction function is the biggest source of political risk in today's markets. We discuss it in detail in this month's report, along with an update on our views of Brazil, Russia, and Turkey. In addition, we examine the potential casualties of the European immigration crisis and the likelihood of Donald Trump becoming the president of the United States.
Expectations of a deepening EM/China growth slump and RMB depreciation have been the key to the selloff in global risk assets. There is no basis for these expectations to improve. Therefore, there are few fundamental reasons for EM and global risk assets to rally much further. Stay put. In Brazil, the impeachment rally is unsustainable and will reverse sooner than later. Stay short Brazilian risk assets.
A stunning 9.9 million-barrel build in U.S. oil inventories this week failed to arrest the upward climb in prices.
Beyond the ongoing short-term rebound, EM currencies have more downside, and will depreciate by more than is implied by their forward rates on a 6-9 month horizon. This makes us reluctant to recommend buying local currency bonds to absolute-return investors. A new trade: Long Russian/short Malaysian equities. We also reiterate our short MYR/long RUB trade.
The recent rebound is not a harbinger of a prolonged recovery in risk assets. The many potential negatives will keep volatility high and trigger further occasional selloffs.
China will neither propose nor support any coordinated initiatives among central banks on the RMB issue in G20 meetings this year. RMB bonds will prove attractive to foreign investors, given their higher yields and lower exchange rate volatility.
We are introducing a new set of fair value models for currencies. On a cyclical basis, the dollar is expensive. However, this is not enough of a reason to expect an imminent fall in the greenback. The yen is extremely cheap, and its fair value is rising on the back of a positive terms-of-trade shock. The yuan is fairly valued. Most commodity currencies are not yet cheap.
The remarkable admission by OPEC's secretary-general, Salem el-Badri, earlier this week that with "any increase in (oil's) price, shale will come immediately and cover any reduction" in output only hints at the larger impact of light-tight-oil (LTO) going forward.
The Chinese authorities are stepping up coordinated efforts to boost the economy. There has been a clear shift of policy focus from the "supply side" reforms to "demand side" management. Quickening credit creation bodes well for industrial activity, the hardest hit sector in the ongoing growth slowdown.