Rate cuts aren’t just a developed markets (DM) phenomenon. Within EM, easing cycles have begun in Chile, Russia, India, Malaysia, and Philippines. Brazil, Mexico, South Africa, Turkey, and Indonesia are expected to begin easing in the coming months. Others will eventually join this group, and so the yield advantage enjoyed by EM is likely to dry up to an extent.
Strong global growth is a more important condition that needs to be fulfilled and we’re not there yet. Things are looking up with regards to US-China trade tensions, and an eventual deal would go a long way in helping the regional economies that are part of the China supply chain. Yet we also know that once China has been addressed, the US will turn its attention to car imports from Japan and Europe.
Lower house rapporteur recently released a report containing proposed changes to Bolsonaro’s bill. Economy Minister Paulo Guedes reacted poorly, calling it a setback and accusing lawmakers of giving into pressure from civil servants. Even though the process continues, relations between the government and Congress are likely to remain strained.
The pension reform bill is undergoing debate in a lower house special committee before moving to a full Congressional debate. Lower house Speaker Rodrigo Maia had hoped to hold the special committee vote in June but that has been pushed into July. That means the first lower house floor vote won’t come until late July at the earliest. Here, 308 votes out of 513 are needed to pass. A second lower house floor vote could come in August or September. Then it would go to the Senate for similar committee and floor votes.
Given all the necessary voting hurdles, there will be lots of delays and horse-trading still to come. President Jair Bolsonaro said he was open to some modifications. However, he stressed that the final bill can’t jeopardize the planned BRL$1.165 trilliion ($312 billion) in savings to be seen over the next ten years. We see a final total of BRL$600 billion in savings over the next ten years. Furthermore, we believe likely delays to an already long process will push final passage well into Q4.
Bolsonaro inherited a sluggish economy and it remains sluggish. The IMF expects GDP growth of 2.1% in 2019 and 2.5% in 2020 vs. 1.1% in 2018. GDP rose only 0.5% year over year in Q1, the slowest since Q1 2017. Data so far in Q2 suggest weakness is carrying over. As such, we see downside risks to these growth forecasts. Indeed, the most recent weekly central bank survey shows market expectations for growth of 0.87% this year, half of what the central bank itself expects.
With growth sluggish and inflation easing markets are now pricing in rate cuts. The CDI market is now pricing in two cuts by year-end that would take the SELIC rate down to 6.0%. The most recent weekly central bank survey shows market expectations for a year-end SELIC rate of 5.75% vs. 6.5% previously.
Yet the agreement, which was made in early June, has no specific targets and leaves open the possibility of other punitive measures by the US. Mexican assets thus remain vulnerable to ongoing political risk. According to the US-Mexico Joint Declaration, Mexico agreed to “take unprecedented steps to increase enforcement to curb irregular migration.” In return, President Trump suspended the threatened US tariffs on Mexican imports.
We probably have not heard the last of this issue. The Joint Declaration contains the clause that other measures may be taken if Mexico’s efforts “do not have the expected results.” No numerical targets were set but Mexico said it could not agree to the zero migrants demanded by the US. Mexican officials said that if its efforts do not yield results (however they are measured) in 45 days, they will look for a broader regional initiative.
The Mexican economy remains sluggish. GDP growth is forecast by the IMF at 1.6% in 2019 and 1.9% in 2020 vs. 2.0% in 2018. GDP rose only 1.2% year over year in Q1, matching the cycle low from Q1 2018. As such, we see downside risks to the growth forecasts. Indeed, Banco de Mexico recently cut its growth forecast this year to 0.8-1.8% from 1.1-2.1% previously.
Banco de Mexico has been on hold since its last 25 bp hike to 8.25% back in December. CPI edged lower to 4.0% year over year in mid-June, back to the 2-4% target range for the first time since March. Bloomberg consensus sees an easing cycle starting by Q1 2020, but much will depend on external conditions and the peso.
The ratings agencies are punishing Mexico. Fitch recently cut Mexico one notch to BBB with stable outlook while Moody’s cut the outlook on its A3 rating from stable to negative. Our own sovereign ratings model has Mexico’s implied rating at BBB/Baa2/BBB and so we are not at all surprised by Fitch’s move. What we are surprised at is that Moody’s still has Mexico at A3.
(For our views on the US-China trade war, please see our Majors section.)
GDP growth is forecast by the IMF at 6.2% in 2019 and 6.0% in 2020 vs. 6.6% in 2018. GDP rose 6.4% year over year in Q1, matching the cycle low in Q4. In light of the tariff risks as well as building global headwinds, we see downside risks to the growth forecasts. For now, our base case remains that China muddles through. That is, growth may slow more than desired due to the trade war, but we do not foresee a hard landing.
Senior China officials continue to downplay risks of weaponizing the yuan. We take them at their word. Chinese Premier Li Keqiang has promised not to weaken the yuan to stimulate exports. He has also acknowledged that a devaluation will do more harm than good to China, and we concur.
We believe recent CNY moves are simply reflecting moves in broader EM FX. The correlation between CNY and MSCI EM FX is around -0.83, which is at all-time highs. It appears that PBOC is simply allowing CNY to trade more in line with wider EM FX. Despite all the bluster from US officials, Treasury has declined to label China a currency manipulator since 1994.
His BJP won an outright majority with around 303 seats, more than the 272 needed to rule on its own and up from the 282 it won in 2014. Opposition Congress hardly improved its standing, winning 52 seats vs. 44 in 2014. This should give Modi free rein to push through structural reforms that stalled during his first term.
The economy is slowing but should eventually respond to increased stimulus. GDP growth is forecast by the IMF at 7.3% in FY2019/20 (ending March 31) and 7.5% in FY2020/21 vs. an estimated 7.2% in FY2018/19. Q1 GDP growth came in much weaker than expected at 5.8% year over year, the fourth straight quarter of deceleration and the slowest since Q1 2014. As such, we see downside risks to the growth forecasts.
No wonder the central bank started an easing cycle in February. It followed that up with a second 25 bp cut to 6.0% in June. Governor of the Reserve Bank of India Shaktikanta Das said then that “Our decision is driven by growth concerns and inflation concerns, in that order.” The decision was unanimous while the bias was moved to accommodative from neutral previously. It doesn’t hurt that Modi was able to replace the hawkish Urjit Patel back in December with the more dovish (and possible more compliant) Das. Further cuts are likely this year.
In the last local elections in 2014, the AKP won control of both Istanbul and Ankara and so these races were key. After the do-over, the opposition CHP won the mayoral vote in Istanbul by an even greater margin. The opposition had a large margin of victory in Ankara.
What happens next? Does President Recep Tayyip Erdogan double down on his confrontational approach? Or does he reach out to work with the opposition? Only time will tell but we suspect he will maintain his populist, statist approach to running the country.
The economy is emerging from recession. The IMF expects GDP to contract -2.5% this year before growing 2.5% next year and 3.6% in 2021. GDP grew a seasonally adjusted 1.3% quarter over quarter in Q1, though it still contracted -2.6% year over year. Commercial bank loans are contracting year over year in both nominal and real terms, while NPLS are rising steadily and likely to spike as the economic slowdown continues.
Price pressures are easing. At this point, the 3-7% target range has been rendered meaningless. CPI rose 18.7% year over year in May, the lowest since August 2018. PPI rose 28.7% year over year in May, the lowest since July 2018. While elevated, both inflation measures appear to have topped out and this brings an easing cycle closer to view.
Turkish central bank delivered a dovish hold in June. In its policy statement, the bank dropped its pledge to “maintain the tight monetary stance until the inflation outlook displays a significant improvement.” Inflation is falling while the lira has stabilized. If this continues, we see potential for the easing cycle to start at the next policy meeting July 25. However, much will depend on how the lira is trading then.
It won with a 57.5% share of the vote, down from 62% in the 2014 national election but up from the 54% in the 2016 municipal elections. This was the best outcome for South Africa, but we remain very negative as President Cyril Ramaphosa must still deal with deep structural issues that are hindering the nation.
His administration still has to deal with the same long-term structural issues as past administrations. That suggests little has been done but perhaps this is being unfair to Ramaphosa. He is clearly trying to eliminate entrenched corruption and graft in the nation and that will take years, if not decades.
Growth remains sluggish. The IMF forecasts growth of 1.2% in 2019 and 1.5% in 2020, up from only 0.8% in 2018. GDP was flat year over year in Q1, while monthly data so far suggest growth is accelerating a bit in Q2. Still, we see downside risks to the growth forecasts.
Price pressures are stabilizing. CPI rose 4.5% year over year in May, right in the middle of the 3-6% target range. Caution is warranted, however, as PPI picked up to 6.5% year over year in April, the highest since November.
South African Reserve Bank delivered a dovish hold in May. Not only did two MPC members vote to cut rates, but Governor of the South African Reserve Bank Lesetja Kganyago said the bank’s model shows a 25 bp cut in Q1 2020. The SARB also cut its inflation forecasts for this year. Both headline and core inflation are seen averaging 4.5% this year vs. 4.8% previously. We think SARB is likely to start an easing cycle in H2. Their next meeting on July 18 seems too soon, but the September 19 and November 21 meetings are live.
This material is provided solely for informational purposes by Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) to recipients who are classified as institutional or sophisticated investors, or as Professional Clients or Eligible Counterparties if in the European Economic Area (“EEA”). BBH is an independent FX research provider and this communication should not be construed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency, security, other asset class or any particular investment strategy. This material does not constitute legal, tax or investment advice. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code or for promotion, marketing or recommendation to third parties. This information has been obtained from sources believed to be reliable that are available upon request. This material does not comprise an offer of services. Any opinions expressed are subject to change without notice. Unauthorized use or distribution without the prior written permission of BBH is prohibited. This publication is approved for distribution in member states of the EEA by Brown Brothers Harriman Investor Services Limited, authorized and regulated by the Financial Conduct Authority (FCA). Please be advised that any analysis of individual countries, currencies, securities or other asset classes contained herein, including, but not limited to, rankings contained in BBH Country Risk Ratings, FX Risk Rankings and Equity Risk Rankings, should not be considered sufficient information upon which to base an investment decision. Such analysis is intended to serve as a preliminary screening tool, which should be supplemented by additional research.
This material contains “forward-looking statements” which include information relating to future events, projected future performance, statements regarding intentions, strategies, investments, expectations, the competitive and regulatory environments, predictions, and financial forecasts concerning future foreign exchange activities and results of operations and other future events or conditions based on the views and opinions of BBH. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements.
Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time the statements are made and/or BBH’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in, or suggested by, the forward-looking statements. Actual results of activities or actual events or conditions could differ materially from those estimated or forecasted in forward-looking statements due to a variety of factors.
There are risks associated with foreign currency investing, including but not limited to the use of leverage which may accelerate the velocity of potential losses. Foreign currencies are subject to rapid price fluctuations due to adverse political, social and economic developments. These risks are greater for currencies in emerging markets than for those in more developed countries. Foreign currency transactions may not be suitable for all investors depending on their financial sophistication and investment objectives. The services of an appropriate professional should be sought in connection with such matters.
BBH, its partners and employees may own currencies discussed in this communication and/or may make purchases or sales while this communication is in circulation.
Information has been obtained from sources believed to be reliable and in good faith. Sources are available upon request. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Any opinions expressed are subject to change without notice. This material has been prepared for use by the intended recipient(s) only. Unauthorized use or distribution without the prior written permission of BBH is prohibited. Please contact your BBH representative for additional information.
BBH is a service mark of Brown Brothers Harriman & Co., registered in the United States and other countries. © Brown Brothers Harriman & Co. 2019. All rights reserved.