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Emerging Market Divergences - Global Exchanges

FICC Podcasts mars 23, 2021
FICC Podcasts mars 23, 2021

Disponible en anglais seulement

In this episode, we discuss two interesting developments in emerging economies around the world. The first is capital inflows and associated reserve accumulation. The second is how the rise in global oil prices has impacted the inflation and monetary policy outlooks.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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*Disponible en anglais seulement

Greg Anderson:

Hi. Welcome to episode four of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my co-host, Stephen Gallo and I, will be talking about two interesting developments in emerging economies around the world. The first is capital inflows and associated reserve accumulation. The second is how the rise in global oil prices has impacted inflation and monetary policy outlooks. The title for this episode is Emerging Market Divergences.

Stephen Gallo:

Hi. I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:

Hi. I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's cohost.

Stephen Gallo:

In each weekly podcast, like today's, we discuss our perspectives on the global economy in the foreign exchange market. We also bring in guests from the FX industry and from related financial markets, like commodities.

Greg Anderson:

We strive to make this show as interactive as possible, so don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants, and not those of BMO Capital Markets, its affiliates or subsidiaries.

Stephen Gallo:

Well, Greg, it's March 23rd, 2021. We're almost through the first quarter of this calendar year. Looking at the quarter as a whole, what's up in your currencies, Greg?

Greg Anderson:

So, what's up in my currencies is, first off, long-term bond yields, second, oil prices, third, FX reserves totals in the number of Latin American countries, and then last, but not least, inflation is up in Latin America, which has even caused Brazil to already raise interest rates. And it's pushed up short-term interest rates elsewhere in Latin America. So, Stephen, what are you seeing as major themes and trends in your currencies?

Stephen Gallo:

Well, in my area, Greg, I think I'd like to start by looking at the ADXY, that basket of Asian currencies hit a high for the year above 110, just as things got going in early January. But interestingly, it has since drifted lower to the point where it's now about 1% lower year to date. Another thing which stands out, I think, is the PBOC's decision to temporarily park dollar RMB at around 6.50. That currency pair has basically been treading water for most of the month of March. And that has coincided with Chinese, A-shares weakening moderately. I think a reflection of the Central Bank starting to normalize policy in a very targeted way.

Greg Anderson:

So Stephen, one of the things you didn't mention for Asia is reserve accumulation. How about that?

Stephen Gallo:

Sure. That's a good point, Greg. On a year-to-date basis, certainly, if we take out the impact valuation effects, it looks like Asian central banks have been moderately growing their reserves. And what's interesting is that this seems to have resulted in Asian currency depreciation versus the dollar. But on that point, I'd like to pass it back over to you. You seemed a little bit worked up about LatAm reserve accumulation in your intro remarks. Do you want to talk a little bit about that, Greg?

Greg Anderson:

Dr. Gallo, for some reason, reserve accumulation triggers me. So let me take a deep breath here. Okay. Here's my back of envelope math. Through the end of February, a US intermediate treasury bond index had a total return of minus 2.7%. The DXY basket of foreign currencies had a negative return of 1.0%. That means that a reserve manager with about 60% of its portfolio in intermediate US treasuries, and about 40% of its reserves portfolio in a Euro-centric basket of foreign bonds, should have seen the value of its reserves drop by about 2.0%.

Greg Anderson:

Now, I'll admit returns might be somewhat different from that. But in this negative of a return environment, if reserves are rising, that's probably due to reserve accumulation by the Central Bank. All right, so here are the stats through the end of February, in data that's reported to the IMF: Brazil's reserves up 0.2%, Mexico's up 0.9%, Chile's up 1.0%. I'm going to go out on a limb and suggest that these countries probably looked at the appreciations they experienced in their currencies in the second half of 2020, and decided that for Q1 of 2021, they were going to accumulate reserves in order to break the US dollar downtrend. So with that said about Latin America, Stephen, is there anything more in emerging Asia that you wanted to highlight?

Stephen Gallo:

Well, first and foremost, Greg, I've got to mention China, because it's the most important Asian player. And the thing to remember here, Greg, as I know you're aware, is that China is a very adept balance of payments manager and also a financial stability risks manager. And in as much as those things are interrelated, I think they help explain a lot of PBOC's actions and what we've been seeing with the currency as well. So first and foremost, we just have to remind listeners that we're coming off a strong period for the currency and the external trade balance. And I think, on the one hand, regulators don't want to encourage excessive hot money inflows. And they're also probably looking ahead to a period when export growth will moderate somewhat, and the trade surplus won't be as large. So I think they're probably happy with a little bit of RMB depreciation here in the short term.

 

 

Stephen Gallo:

The second thing I would point to, and I mentioned this in the intro, is Chinese A-shares. The CSI 300 is down 3.8% year-to-date. And so, on the one hand, we have the local financial stability risks angle here that policymakers are grappling with. But my impression is that policymakers are also a bit unnerved by the backup in long-term yields we've seen, not only because of the potential for spillover effects into their own markets, but also because of the impact that higher dollar rates could have on other emerging markets, many of which do business with China.

Stephen Gallo:

And the third and final thing I would mention is the more dollars Chinese commercial banks are acquiring from investors, who want to own RMB assets, the more potential FX and credit risk sits on those bank balance sheets, which obviously regulators want to manage. So that's the China angle done, I think. Greg, I want to pass it back over to you now. The FX reserve accumulation by LatAm central banks, you mentioned, have you pinpointed any specific side effects of those interventions or other issues which are on your radar screen?

Greg Anderson:

Stephen, the term side effects is an apt one. When the prescription for reserve accumulation was written in late 2020, WTI oil was around $40 a barrel. In LatAm countries, were generally looking at below target inflation numbers. Even though oil is backed off below $60 a barrel today, the quarter-on-quarter rise in oil is pretty spectacular. And that, along with a bit more of a rise in the US dollar than these central banks anticipated, has caused inflation to pick up in LatAm lands.

Greg Anderson:

Brazil's main inflation index printed at 5.2% year-over-year in February, which is way above the 3.75% target. The central bank pretty much had no choice, but to raise its base rate by 75 basis points, and more or less promised another similar rate hike at its next meeting. Mexico's CPI inflation index accelerated to 3.8% year-over-year in February. So almost above the top of Banxico's 3% plus or minus 1% tolerance band. As a result, Banxico is likely to have to stop cutting rates. In Chile, February's CPI came in at 2.8% year-over-year, so maybe the issue isn't quite as pressing there. But for monetary policy in Chile, suddenly the risk is the potential for a rate hike that comes sooner than we think. So, Stephen, how about in Asia? Is the rise in global oil prices causing inflation there?

Stephen Gallo:

Well, it's a bit of a mixed bag, to be honest, Greg, as is usually the case in Asia. On the one hand, I would say the moderate valuation adjusted reserve builds we've been seeing from the likes of India, China, Malaysia, Korea, and Taiwan year-to-date are not really visible in CPI inflation yet, or at all. On the other hand, it does look like supply constraints in a number of areas, due to COVID-19 shutdowns and limited mobility on the part of migrant workers, have caused some food and agricultural prices to rise sharply. And this has been noticeable in consumer price baskets in places like India and the Philippines to just name a couple of countries.

Stephen Gallo:

You mentioned energy prices. In terms of energy prices, I think you're starting to see wholesale and producer prices creep up in terms of PPI inflation. But as of right now, I wouldn't say that the Asia ex-Japan region, as a whole, does not suffer from seriously accelerating inflation. For instance, China's annual rate of inflation was minus 0.2% in February. Core inflation in China is muted. South Korea's headline inflation was a little over 1%. India's rate of inflation, although notorious for being above that of its Asian peers, is now back below the RBI's upper tolerance limit. And Indonesia, Taiwan, Thailand, Malaysia, and Singapore all have inflation rates that are either around plus 1% year-over-year or negative. So, that's the story in Asia.

Stephen Gallo:

Greg with all the color you provided on LatAm, are there any currencies what you would highlight specifically as your favorites for the next quarter?

Greg Anderson:

I would point out that for the LatAm countries, they just don't generally have the current account surpluses and external flow profiles to make the currencies appreciate simply by backing off a reserve accumulation, or even by raising rates. But among them, I like Mexico's external flow profile the best. I think Mex peso will outperform in the Latin America basket over the next quarter. I also think it could outperform G10 currencies, like especially the EUR, but also even CAD in the upcoming quarter. How about in Asia? Which currencies do you like or not like for Q2?

Stephen Gallo:

So Greg, in the environment we're now in, I think we're going to see global investors be a lot more discerning when it comes to the concentration of their EM exposures. And along those lines, I think an EM proposition has to have at least the following three attributes: it has to have an improving growth story and a yield curve to assist with bank profitability; it has to have reasonably good carry relative to various domestic risk; and it has to have sound balance of payments management techniques. And the currency in Asia, I think that fits this profile, right now, is the Indian rupee.

Stephen Gallo:

There are a couple of other things I'd mentioned too, in addition to limited external vulnerabilities relative to some of its EM peers, I think India also has a very engaged and proactive central bank that's managing the sovereign debt market, if you like, but not completely eroding real yields altogether either. So it's a much less aggressive form of managing the sovereign debt market than, say, quantitative easing. The Central Bank is also starting to slowly mop up some of the huge liquidity injections it engaged in over the past year to support the banks. And one way it is doing this is through purchasing foreign currency at a slower pace than it did during the second half of 2020.

Stephen Gallo:

So as we noted at the beginning of this podcast, Asian central banks have been in building up some of their reserves, but India has been doing this at a much slower pace than during the second half of 2020. So in terms of how to look for this relatively supportive environment for the INR in terms of the currency pairs, I think there's room for India to drift a little bit higher versus China over the coming one to three months (i.e. CNHINR lower). I also think a short EURINR is a good way to be exposed to India, because you have the carry there, then you have the profile for India, which I just mentioned.

Greg Anderson:

I think that's a good note for us to end on. If you're still here, thank you, listeners, for sticking with us through the end of this episode. We will be back with another episode next week.

Greg Anderson:

Thanks for listening to Global Exchanges, listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns, Incorporated, and BMO Capital Markets Corporation. Together, BMO, who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding or foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy referenced herein may be suitable for you.

Speaker 3:

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Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe



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