“Remain positive on Brazilian interest rates”, advise Credit Suisse fixed income analysts Igor Arsenin and Nilto Calixto. They reckon that Copom, the Brazilian monetary policy committee, will cut rates by only 25bps at its August meeting, and have shifted their end-of-year forecast for the Selic (special settlement and custody system) rate from 13.75% to 14.00%, while maintaining a 12.00% forecast for year-end 2007. The Central Bank is taking a conservative stance, so as to evaluate the effects of 500 bps in rate cuts since last September.
The impact on interest-rate swaps will be “limited to the very short end of the curve”, and it is most likely that longer-dated swap rates to continue to decrease, Arsenin and Calixto write. “Risk appetite is gradually returning to global markets, and we have recently observed an increase in foreign interest in Brazil local market products, however it is well below the peak demand earlier in the year.” In this environment they recommend extending duration on the pre-CDI curve to Jan 10 tenor.
In Colombia, government has to manage the fallout from financial contagion, “but the medium-term credit outlook still appears favourable and relative external debt spreads now look attractive relative to peers”, say senior LatAm economist Fernando Losada and strategist Siobhan Morden at ABN Amro. They “particularly like” Colombia’s US$ 2017 bonds, and recommend a long position in those against a short position in Brazil US$ ‘15s.
Jonathan Anderson, UBS’s chief economist (Asia), this week once again commented on the Chinese cycle, in view of the “inordinately strong” GDP data for the first half of the year and a series of new policy announcements, climaxing with prime minister Wen Jiabao’s hawkish comments on the economy last week. The economy is “not out of control”, Anderson emphasises: the government has “strong incentives not to over-respond”, and there’s “much less to the property control measures than meets the eye”. The government’s aim there is to clamp down on high-end speculation in the housing market, he argues.
On yuan appreciation, Stephen Green, senior economist at Standard Chartered, argues that this “medicine, prescribed to solve China’s trade imbalance” will actually exacerbate the problem in the short term. China essentially has two economies, writes Green – a “real” economy, and a processing economy (of firms that import, process and export again). Yuan appreciation will reduce the cost of these processing companies’ input purchases, a factor to which Green believes insufficient attention is paid.
In CEMA, Zsolt Papp, analyst at ABN Amro, points out that inflation and growth data have “surprised on the high side, compared with consensus forecasts”. ABN sees scope for correction in Hungary, Poland and Turkey. “In Hungary, the risk is that inflation forecasts remain too low, which would limit the scope for a correction in the euro-forint exchange rate.” On Hungarian interest rates, Papp’s baseline scenario is for a 7.5% NBH reverse repo rate by the end of 2006, but he acknowledges that there is a valid case for rates “up to 300bp higher” than that.
Dresdner Kleinwort’s emerging markets research team focuses in a comment released on Tuesday on the problem of rising risk appetite and diminishing value. “EM sovereign spreads, bonds and CDS have almost recovered the levels that were prevalent before the May sell-off”, write Arko Sen and Arnab Das. “The curve gets steeper and convex as volatility rises and vice versa”, they write. The recovery in spreads “seems to have occurred in relatively low volumes”; the primary market has seen much cash being put to work, but remains shallow despite some improvement in risk appetite. Spreads are “vulnerable” in the coming week, with a large volume of data expected.
The Dresdner Kleinwort team last week issued a study on emerging market FX markets. Das and strategist Jon Harrison ask whether there is a negative correlation between interest rates and FX returns – “high yield currencies underperform low yielders”. They observe that in recent weeks, improved external conditions have caused a return to high-yielding currencies, “but the picture over the past few months suggests a shifting balance between the dependency of returns on interest rates and fundamentals.”