Exposure to Mexico, Chile and Israel offers genuine diversification – Ashmore’s Dehn

Jan Dehn, head of Research at Ashmore discusses how exposure to Emerging Markets offers investors genuine diversification, while exposure to developed economies is increasingly akin to making a single bet.

Developments in Emerging Markets continue to reflect the enormous variety across countries in the asset class. Among the stronger credits in EM we highlight the following country specific developments from the past week:

• Mexico: Domestic demand-led cyclical slowdown continues with the release of retail sales data, which was weaker than expected at -0.41% m-o-m seasonally adjusted for the month of September, though we think this positions Mexico for a very strong performance in 2014, aided by the raft of reforms being implemented by the Pena Nieto administration.

• Malaya: Moody’s raised the outlook for Malaysian government bond and issuer rating from stable to positive, citing improvements in fiscal policy, the reform agenda, and economic stability in the face of volatile external markets.

• Chile: Chile’s central bank cut the policy rate by 25 bps to 4.5%. This follows a 25 bps cut last month. Chile has little inflation and its currency has been stable in the face of negative EM sentiment. Chile’s real GDP growth rate accelerated in Q3 to 4.7% y-o-y from 4.0% y-o-y in Q2, driven mainly by strong export growth. It is a show of strength that the central bank feels that it can cut rates as and when it feels the need to do so.

• China: Chinese officials announced that China intends to widen the trading band for the currency and eventually remove quotas limiting access for foreigners into China’s domestic markets. This follows other major reforms announced in the past few weeks.

• Israel: Growth slowed in Q3 compared to Q2 as the pace of expansion declined from 4.6% q-o-q to 2.2% q-o-q. However, a number of indicators – including solid consumption growth, rising imports of capital goods and base effects – suggest that Israel’s growth outlook is improving as we head into 2014.

• Russia: IP growth in Russia softened, posting at 0.1% y-o-y decline. The performance of manufacturing in Russia is mixed across industries, but overall the domestic industrial sector is going through a soft patch at the moment. However, inflation still runs at relatively high levels, so significant policy easing is unlikely at this time.

• Singapore: Non-oil domestic exports rose 2.8% y-o-y in October, far more than consensus expectations (-1.1% y-o-y). Unlike many other Asian economies, Singapore’s economy is particularly dependent on demand in Japan and the US as well as Asia and Indonesia. The pick-up in exports is therefore noteworthy, in our view.

Among the prominent EM countries currently undergoing macroeconomic adjustment, we highlight the following developments from last week:

• Turkey: Turkey’s central bank turned more hawkish in the past week, even as it left the bulk of its myriad of policy instruments unchanged. In a clearly hawkish development, the central banks removed the one-month repo facility, a source of liquidity for banks.

• South Africa: CPI inflation declined to 5.5% y-o-y in October from 6.0% y-o-y in September. Core inflation was unchanged from September at 5.3% y-o-y. We expect the South African Reserve Bank to remain on hold for the foreseeable future.

• India: India’s central bank governor Raghuram Rajan announced root and branch reform of the heavily statebank-dominated banking sector in India. This is an extremely positive development, in our view.

• Brazil: For the third month in a row fiscal revenues were stronger than expected. Higher tax revenues from corporates and real wage dynamics were the main reasons for the better performance.

Global backdrop
The global backdrop continues to be dominated by central bank policy, notably in the US. Stronger than expected US retail sales took the current pace of US Q4 growth to about 1.6%, while the FOMC minutes were deemed to be less dovish than expected, thus keeping the issue of tapering firmly at the top of the list of global market drivers. The issue of tapering is not going away, because the rationale for scaling back asset purchases – fear of financial sector bubbles and the economic consequences when they collapse – has not gone away. But the FOMC does not yet seem to have reached agreement on how to anchor interest rate expectations once tapering starts. Indeed, Fed Chairman Bernanke spent considerable time last week reiterating that tapering is not the same as rate hikes, a statement the market completely ignored when he first made this point in May.

The real challenge is not how to anchor the short end but how to anchor long rates. With verbal guidance in tatters after Bernanke’s bruising treatment at the hands of the bond market over the summer, we believe the Fed’s only tools for managing the long end are QE itself and twist operations. But the room to twist is narrow and if QE is to be scaled back it is hard to see how the Fed can prevent another sell-off in long rates. The Fed was, after all, the only buyer of US treasuries in net terms in Q2. Volatility in US long rates could soon make a return.

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