The global backdrop for emerging markets (EM) remains challenging. The Fed was not as dovish as markets hoped last month and so the liquidity story leaves something to be desired. Furthermore, the liquidity story by itself was never enough to support a sustained EM rally. What’s really needed is a better global growth story and we are far from it.
The intense bout of retaliatory escalation of tariffs appears to have ended. Now we are in a fragile truce as trade talks continue. Until we get a deal, planned tariffs will still go into effect December 15. This comes after another round went into effect September 1. As of this writing, US has slapped tariffs on $550 billion of Chinese goods, while China has done the same on $185 billion of US goods. There have been several rounds of tariff exemptions announced by both sides in recent weeks.
US Treasury Secretary Steven Mnuchin said Chinese Vice Premier Liu He will head to Washington the week of October 7 for another round of talks. Mnuchin added that the Chinese trade delegation’s visit to US farms has been rescheduled, even as China just gave tariff waivers to several companies to buy US soybeans. We simply cannot get excited about what seems to be a mildly improved mood in the talks.
Taiwan and Korea are viewed as regional bellwethers. Taiwan export orders contracted -8.3 percent year over year, suggesting little relief over the next six months. Elsewhere, Korea reported exports contracted -21.8 percent year over year for the first 20 days of September. If sustained, it would be the worst monthly showing since 2009. Countries in the Greater China supply chain will continue to suffer until the trade war ends.
In that regard, we see no deal in sight. US President Donald Trump took a confrontational tone with China in his speech to the UN General Assembly. He has said that he doesn’t need a deal before the November 2020 election. At this point, it appears neither nation has felt enough pain to get a deal done. That may change as we move into 2020.
The People’s Bank of China (PBOC) cut reserve ratios for all commercial banks by 0.5 percentage points. The cut was widely expected and became effective September 16. The ratio for some city commercial banks was cut by one percentage point that becomes effective in two steps on October 15 and November. All told, the cuts will release CNY900 billion into the system. For now, the PBOC is unlikely to ease aggressively.
PBOC just lowered the one-year loan prime rate five bp to 4.20 percent, as expected. However, it left the five-year loan prime rate (LPR) steady at 4.85 percent. Under its new framework, the central bank sets these benchmark reference rates on the 20th of each month. Officials have been easing policy steadily in recent months but have refrained from aggressive rate cuts. We believe this strategy will continue as the trade war extends with no end in sight.
Hong Kong Chief Executive Carrie Lam announced the withdrawal of the controversial extradition bill. Previously, it had only been suspended. We view the move as simply too little too late. Protest leaders say they want all five key demands met. It’s not expected that Lam or the mainland China government will meet them and so we expect the protests to continue and tensions to remain high.
Rating agencies have punished Hong Kong. Fitch cut Hong Kong’s sovereign rating a notch to AA with negative outlook, warning that recent events have inflicted long-lasting damage to investor perceptions of the quality of Hong Kong’s governance and the rule of law. Elsewhere, Moody's cut the outlook on its Aa2 rating for Hong Kong from stable to negative, warning of rising risks that ongoing protests erode the strength of Hong Kong's institutions and damage its attractiveness as a trade and financial hub.
President Recep Tayyip Erdogan sacked central bank Governor Murat Cetinkaya on July 6, ostensibly for not cutting rates quickly enough. In early August, several high-ranking central bank officials were fired, including Chief Economist Hakan Kara. Others that were fired include the central bank’s head of research, the banking department chief, and the risk management chief. These developments support our negative view on Turkey, and we think Turkey faces even stronger downgrade risks to its B+/B1/BB- ratings.
With Erdogan fully in charge, the central bank has delivered two straight dovish surprises. The first cut was 425 bp and the second was 325 bp, both larger than expected. The next policy meeting is October 24. If the lira continues to hold up relatively well and inflation eases further, another large cut is likely then. However, we do not believe Erdogan’s professed plans for single digit interest rates and inflation will come to fruition anytime soon.
Despite the sluggish economy, South African Reserve Bank (SARB) kept rates steady in September. The decision was unanimous, and the bank added that future policy decisions will be data dependent. SARB cuts its growth and inflation forecasts and yet did not feel the need to cut rates. Inflation remains in the bottom half of the 3-6 percent target range while the real economy remains weak. If current trends persist, a cut is likely at the next meeting November 21.
The fiscal outlook remains poor due in large part to the Eskom bailout and could be the trigger for further downgrades. Finance Minister Tito Mboweni will deliver his mid-term budget statement October 30, a week later than originally planned. Our own rating model shows South Africa’s implied rating steady at BB-/Ba3/BB- after falling a notch last quarter. Moody’s and Fitch’s ratings of Baa3 and BB+, respectively, are seeing heightened downgrade risk. Loss of investment grade from Moody’s would lead to ejection from the World Government Bond Index (WGBI). Even S&P’s BB rating appears too high now.
BRL has been underperforming after the Central Bank of Brazil’s Monetary Policy Committee (COPOM) cut rates 50 bp to a record-low 5.5 percent in September. That move was expected but the language supports market expectations of another 50 bp cut at the next meeting October 30 and perhaps more at the December 11 meeting. We think that is simply too much for investors to swallow, as investors have always needed a significant risk premium for holding Brazil assets.
Developments on pension reforms have been largely positive. The reforms have been passed by the lower house and have moved on to the Senate. Total savings are now estimated to be around BRL1 trillion over the next decade and have largely remained intact from initial estimates of BRL1.3 trillion. Furthermore, the pace of congressional passage has been relatively quick. We note that our own model has Brazil’s implied rating steady at BB/Ba2/BB. Actual BB-/Ba2/BB- ratings are likely to eventually be upgraded once the reforms have been signed into law.
Banco de Mexico delivered a dovish surprise last month and cut rates 25 bp to 8.0 percent. It followed up with another 25 bp cut this month. Consensus sees a slow and steady easing cycle over the next year that takes the policy rate down below 7.0 percent by early 2021. Much will depend on global developments, but we believe the central bank will try to unwind its tightening cycle as quickly as it can in a prudent manner.
The fiscal outlook remains poor due to slow growth and the drag from the $5 billion bailout for Pemex. S&P downgraded Mexico a notch to BBB back in June, which lines up with our own model rating. As such, we see ongoing downgrade risks to S&P’s BBB+ and Moody’s A3 ratings. Elsewhere, the United States-Mexico-Canada Agreement (USMCA) remains bogged down in the US Congress.
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