Investec Asset Management argues that many emerging markets are now more lenient towards currency strength. Under Brettons Woods II certain Asian central banks have kept their currencies weak through currency intervention and building up dollar reserves but there is now substantial evidence that such policies are beginning to bite. “As emerging market central banks buy dollars (and hence sell their own currency) they are flooding their domestic market with liquidity.
Sterilisation of this liquidity by issuing bonds can be costly – the interest rate received on your dollar investments is often lower than the interest paid on the bonds issued (interestingly, this is not the case for low yielding China). High domestic liquidity can lead to an overheating domestic economy, to inflation and to asset bubbles”. But they argue that now there is increasing evidence that central banks are more relaxed. “Over the past month China, widened the daily trading band for the renminbi, the Indonesian central bank moved its ‘comfort range’ for the rupiah by more than 5% and Kuwait removed the pure US dollar peg and revalued its currency”.
They point out that, ultimately, any shift in policy will be very gradual and because many countries especially in Asia would not want to give up their export led competitive edge, especially as much currency appreciation is often driven by speculative inflows. They conclude: “emerging market currencies are likely to continue their path of appreciation. This is one of the reasons for our positive long-term outlook on local currency emerging market debt.”
- Standard Bank argues that upward inflationary pressure in Russia means the central bank will have no choice but to strengthen the rouble against the dollar, or change its weight in the currency basket. This is because of the large capital inflows the country is witnessing as result of IPO’s and corporate borrowing on the international, capital markets. They explain that the CBR is misguided in its analysis of inflation: “the CBR also that a slowdown in inflation growth during last August and September, due to lower prices on fruits and vegetables, will be repeated this year as well” but that the comparison is inaccurate as this year the country has had to deal with record capital inflows, which have reached $60 billion.
They argue that an increase in inflation would not be politically acceptable: “In the wake of the parliamentary and presidential elections, combating inflation will be more important than defending the rouble from appreciation, especially since there is little evidence that a stronger rouble has had any meaningful negative impact on the economy.”
They conclude that in order to gain from a coming rouble appreciation and to shield oneself from a possible correction in the bond yields, investors should: “position themselves at the short end of the rouble sovereign curve or buy the two-year Russian Railways bonds.”
- Deutsch Bank discusses the 50 bps rate hike in South Africa this week. They observe that the SARB are hawkishly focused on the medium term outlook and expect rates to be on hold at 9.5% this year. They caution: “here are four significant risks to our view. They are 1) a significant probability of inflation exceeding the SARB’s current expectations, 2) oil prices remaining at current levels, 3) a further increase in general inflation expectations, and 4) developments in the current round of wage negotiations.”
They also observe that developments in consumer spending and current account deficit need to be observed. “in our view developments in GDP and the trade balance, or indications of income growth and price developments, both suggest an easing in consumer spending growth to 7.0% in Q1 from 7.8% in Q4. We have argued that one of the big drivers of consumer spending growth over the last few years has been the improvement in terms of trade. By our estimates SA’s terms of trade improved in Q1, but flattened out in Q2.”
They conclude with the trade advise: “Our year-end bond forecast, based on fair value for 10- year yields, remains 8.25%. Yields have now increased to 8.15% from 7.50%. If 10-year yields increased to within the 8.25% - 8.50%, we would advocate buying bonds.”