Emerging Markets: What has Changed

1) Malaysia’s central bank kept rates steady at 3.25%, as expected, but cut bank reserve ratios from 4% to 3.5% 2) S&P downgraded Poland one notch to BBB+ with negative outlook 3) Brazil’s central bank did a complete about-face and left rates steady at 14.25% 4) Mexico may tweak its FX auction program again when it is extended this month 5) Argentine officials met with IMF chief Lagarde at the World Economic Forum in DavosIn the EM equity space, Russia (+5.9%), Colombia (+2.0%), and Thailand (+1.8%) have outperformed this week, while Qatar (-6.8%), UAE (-5.1%), and the Philippines (-3.7%) have underperformed.  To put this in better context, MSCI EM rose 0.1% this week while MSCI DM fell-0.2%.

In the EM local currency bond space, Malaysia (10-year yield -27 bp), South Africa (-16 bp), and Indonesia (-14 bp) have outperformed this week, while Colombia (10-year yield +23 bp), Hong Kong (+23 bp), and Poland (+11 bp) have underperformed.  To put this in better context, the 10-year UST yield rose 2 bp this week.

In the EM FX space, MYR (+2.4% vs. USD), CLP (+2.0% vs. USD), and ZAR (+1.8% vs. USD) have outperformed this week, while RUB (-2.0% vs. USD), ARS (-1.9% vs. USD), and BRL (-1.8% vs. USD) have underperformed.

1) Malaysia’s central bank kept rates steady at 3.25%, as expected, but cut bank reserve ratios from 4% to 3.5%.  We thought that the bank might become more dovish later this year if the economy remained sluggish, but it appears that the continued slide in oil got them to move sooner rather than later.  Outright rate cuts are still possible in 2016, as Prime Minister Najib is expected to soon revise growth and budget forecasts in recognition of lower than expected oil prices.

2) S&P downgraded Poland one notch to BBB+ with negative outlook.  Our own sovereign ratings model continues to highlight strong downgrade risks given its implied rating of BBB/Baa2/BBB.  This compares to actual ratings of BBB+/A2/A-, so all three agencies should continue to cut Poland.  We had thought the rating agencies might give the new government a bit of a honeymoon, but Law and Justice have shot themselves in the foot quickly, right out of the gate.  As such, it was basically too much for S&P to ignore.

3) Brazil’s central bank did a complete about-face and left rates steady at 14.25%.  This came after weeks of hawkish signals by officials that had the markets looking for a 50 bp hike.  That is, until Tombini’s dovish comments Tuesday pushed expectations back to a 25 bp hike.  Instead, we got no move by a 6-2 vote (the 2 dissenters wanted a 50 bp hike) and rising suspicions that the bank succumbed to government pressure to keep rates steady.

4) Mexico may tweak its FX auction program again when it is extended this month.  The last time it was extended in November, the program was also adjusted.  Finance Minister Videgaray said that while he sees the possibility of "some marginal change" to the dollar sales designed to boost peso liquidity, the decision will need to be taken by the currency commission that he leads."  In related news, Banxico Governor praised the FX auction program.  He added that the FX commission needs to evaluate the program, but also that it’s too early to say if it needs to be changed.

5) Argentine officials met with IMF chief Lagarde at the World Economic Forum in Davos.   Finance Minister Prat-Gay and central bank Governor Sturzenegger reportedly hope to resume formal ties with the IMF.  Re-establishing ties would allow the IMF to conduct its first review of the Argentine economy since 2006.  This would be just another step in the new government’s efforts to come back to the global financial system.(from my colleague Dr. Win Thin)