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Emerging Markets

EM surprises as spreads snap back within hours of election shocker

Empire State Trump 2016 PA 230x150

Remarkable resilience in the face of an uncertain future was the tale of emerging market bond prices on Wednesday as Donald Trump won the presidential election in the US, much to the surprise of EM traders themselves, who expected the risk aversion to last much longer. But the outlook for EM bonds under a Trump presidency is far from rosy. Latin America has been the clear underperformer so far but more pain is expected.

“I thought the sell-off in risk would have lasted longer,” said Paul Greer, senior trader of fixed income at Fidelity International. ”It is almost as if the market is pressing fast forward and wanting to get to the next stage quicker.

“We got in at 6am and things looked pretty soft. CDS spreads and sovereigns in [the European] zone were about 20bp wider, and we’ve pretty much recovered half of that. This mirrors the price action on EM currencies. It only lasted a few hours but the memory of Brexit is strong.”

By lunchtime on Wednesday, CEEMEA sovereign five year CDS spreads were 5bp-10bp wider, with Latin America CDS 10bp-20bp wider. Even Mexico’s euro trade had recovered from 40bp-50bp wider to just 30bp by lunchtime. South Africa and Turkey had also recovered nearly half of the initial losses incurred as the US election result was declared. South Africa was 20bp wider but had come in to 12bp by lunchtime. Turkey was trading 10bp wider.

While long bonds form the likes of Saudi Arabia, South Africa and Turkey were as much as two cash points down, this was largely due to underlying rates movements, and the spread widening was minimal, according to another EM bond trader.

It is as if the market was hurrying to anticipate a rally, like that seen in the wake of the UK’s decision to leave the EU in June, and in doing so prompted one, said an EM syndicate banker.

“The initial knee-jerk reaction has been very quickly corrected,” the banker said. “Given Trump’s pro-business stance, and the trajectory of the US economy, it seems like people were trying to pre-empt the rally back in. [My concern] is that we have corrected perhaps more quickly than we should have, or too far.”

Huge inflows into EM funds this year has meant that investors were poised to buy on the dips, said Fidelity’s Greer. “There is plenty of cash on the sidelines and investors will use that to pick up cheap assets. There was always the expectation that the sell-off would be quite short and investors are remembering the post-Brexit experience. We saw a very strong performance in Q3.”

In addition, Trump’s erratic campaigning style has done little to shed light on what US policy under his leadership will be. There have been broad brush comments about new directions in trade, increasing isolationism and protectionist policies, all of which are expected to negatively impact long term growth. But beyond that, there are simply “best guesses about economic policy with little colour and clarity,” as one EM syndicate banker put it.

A second EM origination head was even more direct. “What does he stand for?” he asked. “Everything is conjecture at the moment, we don’t have a clue.”

It will take some time for the true impact of Trump’s presidency to take effect. But there will be winners. Turkey, Russia and the Philippines have been quick to congratulate the US’s new president and there is an expectation that Russian sanctions will be eased, if not lifted.

And there will be losers. Mexico and the rest of Lat Am will be under close scrutiny.

However, technical factors are still supportive of EM assets and traders will continue to act on these before more concrete US government policies appear. Central bank policy remains key and a Trump presidency is expected to result in more accommodative monetary policy worldwide.

EM has proved itself resilient to shocks throughout the year. As Jan Dehn, chief economist at Ashmore pointed out, the US presidential election is the fourth major risk event of 2016, all of which could conceivably led to a material sell-off in EM assets. But after Brexit, the Turkish coup attempt in July, and the misplaced expectation earlier this year that the Fed would raise rates three times this year, EM asset prices held firm.

Most argued that this has been driven by strong inflows into EM, and low global rates, which are expected to continue.

Fidelity’s Greer said that he now expects only a 50% chance of a 25bp rate hike in December, down from an 80% chance on Tuesday.

Lower rates and a weaker dollar are supportive factors for most emerging markets. Ashmore’s Dehn argues that the majority of investment in EM is from real money accounts who “tend to buy on the dips, which tends to limit the downside risks.”

Latin America ‘centre of the storm’

Lat Am markets appeared just as unprepared as the rest of the world for the election of Donald Trump as US president, as the Mexican peso experienced its worst fall since the Tequila crisis of 1994 overnight. Trump’s anti-Mexico rhetoric has led to the peso — one of the most liquid assets in EM — becoming a proxy for bets on the election among EM investors.

In new bond issues, bankers had been unsure of the effect of a Trump victory and were largely banking on a Clinton victory for a serene end to 2017. With US trading yet to open at the time GlobalCapital went to press, initial signs were that global bond markets were less affected than equities and currencies. Still, the unprecedented nature of the election and the sense of uncertainty mean that the two high yield debut borrowers, Colombia’s Tecnoglass and Honduras’s Atlántida are unlikely to rush to market.

But Mexico itself appeared to have had a plan for the post-election volatility. Central bank Banxico will hold an emergency board meeting on Wednesday and has scheduled a press conference for the afternoon. Expectations among economists range from an indication of future hikes to an immediate rate hike of as much as 150bp to defend the peso. 

As an issuer, too, Mexico has showed that being known as one of the shrewdest borrowers in EM has tangible benefits. The sovereign has taken advantage of favourable conditions to raise around $9.5bn in international markets this year, covering all of its 2017 debt maturities.

Life is unlikely to get any easier for El Salvador, which Moody’s downgraded by two notches to B3 and left on negative outlook on Monday due to a rapidly deteriorating liquidity situation.

Indeed, Mexico is far from the only Lat Am country that could face serious consequences from a Trump presidency. Smaller central American economies such as Guatemala, El Salvador and Honduras depend on unauthorised remittances from the US for a decent chunk of their GDP. And in Colombia, unequivocal US government support for a renegotiated peace deal could be in doubt.

Russia a ‘clear winner’

In central and eastern Europe, the clear winner from the Trump fallout was Russia. After a sharp overnight sell-off, the rouble bounced back from a low of 64.7 to the dollar to 63.3 by mid-morning in Europe. Russian equities also caught a strong bid, with the Micex index up nearly 1% in morning trading.

“Overall we think the Trump victory is good for Russian assets,” said a DCM banker in Moscow. “This should maintain the recent momentum we’ve seen in issuance of Eurobonds by Russian names.”

This could be tested as early as Thursday, when Gazprom is due to price a euro-denominated bond. Bankers said market conditions were unlikely to cause the transaction to be postponed. “I’d be very surprised if they don’t come to market as planned,” said one.

By contrast, Ukrainian assets suffered as investors speculated that a Trump presidency would mean weaker support for the country’s reform efforts and conflict with Russia.

Sovereign bonds were down two points in the long end and one point in the short end by mid-morning, although bankers warned that volumes were very thin.

Konstantin Kucherenko, a fixed income trader at Dragon Capital, said the mood in Kiev was sombre but stable. “Nobody is happy about the result but it still remains to be seen how Trump’s administration shapes up,” he said. “People are in a wait and see mode rather than outright panic or worry.”

Elsewhere in the region, Hungarian assets were reported to be slightly better supported than their Polish counterparts, possibly due to the enthusiasm for Trump shown by Hungary’s prime minister Viktor Orban.

Bankers noted, however, that in fixed income markets the moves were limited. “The Russian government curve is 0bp-2bp wider, while Poland is 2bp-3bp wider, so there’s not a sharp distinction,” said a syndicate banker in London.

Trading volumes in central European bonds were also reported to be thin on Wednesday morning. “That’s partly because we’re close to year-end and partly because the US is not in yet,” he said. “People will be looking to the US for direction because it is a US event.”

He stressed, however, that the overall impact of Trump’s victory had so far been muted. “The main point is that there certainly hasn’t been a big sell-off,” he said. “This doesn’t feel anywhere near as bad as Brexit.”


Mid East resilient though US policy adds risk

GCC bonds opened 7bp-15bp wider this morning although Abu Dhabi and Qatar have outperformed at 3bp wider. Saudi’s new bonds were 10bp wider on the break. Abu Dhabi’s 2026s were 7bp wider, Qatars 2026s were 10bp wider, Bahrain and Oman’s bonds were 7bp and 12bp wider respectively.

“I think it is remarkable how markets are seemingly unaffected,” said one EM banker. “Five year US Treasuries were 10bp tighter this morning and now are back to Tuesday’s levels. The Middle East started the day wider, but levels have begun to tighten over the past couple of hours.”

This may be driven by local Gulf Co-operation Council accounts buying on the dips, he said.

In the longer term, analysts expect further widening in GCC spreads. Exotix Partners noted that the introduction of unpredictability in US foreign policy will likely increases already elevated risk premia in the Middle East.

The impact on Saudi Arabia specifically will be neutralised however by a combination of dollar weakness, and expected commodity price increases, from the perspective of foreign investors, Exotix said.

In Turkey, sovereign CDS widened by around 12bp to 277bp on the break while cash was trading 10bp-15bp wider. Spreads had recovered to 10bp wider by lunchtime. Similar moves were seen in corporates and financials.

The Turkish lira was down by 1.5% to 3.20/$, reflecting the economy’s significant external financing requirement.

Africa to benefit from low rates

The South African rand, which usually serves as a proxy for global events was 1.6% down at 9am London time on Monday, having recovered from a 4% loss. South Africa’s sovereign bonds had recovered to 10bp wider by midday on Wednesday.

The impact of Trump on sub-Saharan Africa is expected to be neutral to negative. Exotix Partners writes that a more dovish path for US interest rates may be supportive of EM risk, and help those with big financing plans like Nigeria, Angola and Ghana. But again, rising risk premia due to uncertainty over trade policy and threats of protectionism could counterbalance this.

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