Our bias remains to fade USD rallies, adding to this view against CNH and MYR this week. We like 3M USD/CNH put spreads to play a grind lower in spot into year-end. A heavy political calendar, improving balance of payments, still-tight capital controls and corporate long USD positioning back the view. The MYR is cheap, trading with a lower beta to USD strength, offshore positioning has stabilized and the policy bias could favor a stronger FX as elections loom. We continue to hold USD shorts against TWD and THB on large surpluses and potential US pressure. We maintain USD/PHP longs, but high carry and grinding moves are muting the risk-reward. In bonds, we are moving towards a market-weight bias. Supply is lighter into Q4, but we are wary of aggressive duration views. In swaps, we keep paid positions in 5Y CNY NDIRS where domestic liquidity will remain volatile, recommend 1Y/5Y INR steepeners on poor technicals and fiscal slippage risks, keep 2Y/10Y KRW steepeners, and receive KRW 1Y/1Y with front-end pricing for BoK looking excessively hawkish.
FX: Stay in defensive longs while waiting for more clarity on USD direction. We favor the BRL (vs. CLP) in LatAm and both RUB (vs. USD and also CAD for some oil protection) and PLN vs. EUR in EMEA. They score well on BoP, level of real rates, FX reserves and business cycle. EUR/PLN also posts a low beta vs. US rates and light positioning. Wait for better levels to sell USD/MXN - the V-shaped trajectory we expected for the pair has materialized but recent political headlines and more difficult NAFTA negotiations bode for caution. Stay long PEN on underperformance vs. copper and likely reduced intervention.
Credit: Relatively hawkish Fed comments and upside risk in the USD helped induce some weakness, but compressed US rates and robust inflows will keep the markets supported. We remain cautious on Venezuela and continue to recommend positioning for price equalization - favoring low-priced bonds. We would gradually add Qatar risk as situation improves, which we expect. Maintain AZERBJ 24s vs. SOIAZ 23s and Argentina 36s vs. 28s.
In our FX Special, we share our thoughts on MAS’ latest policy review. MAS kept their neutral policy stance and did not give any explicit tightening signal, disappointing a market that had been angling for a more hawkish outcome. MAS’ reference to keeping neutral policy for “extended period” was more backward-looking in today’s statement, but they are unlikely to have repeated this phrase without purpose. MAS is retaining maximum policy flexibility for next year, where they see growth moderating and inflation benign. We have also reweighted the DB SGD NEER series, correcting for a small overestimation bias in our model. The new DB SGD NEER is trading 0.95% above the mid-band at the time of writing. We are marginally biased to trade SGD from the short side, or as a funder for our regional longs.
Credit: Demand for EM external bonds remains strong despite rising US rates. We remain constructively positioned in high yielders with a growth momentum, including Argentina, Brazil, Ecuador, and Ukraine. We take profit in Egypt 47s vs. 40s and YPF25s vs. 24s, while maintain Pemex 27s vs. Mexico 27s and PETBRA 22s vs. 8.375% 21s. We stay long 5Y basis in South Africa and Turkey.
Economics Focus: We expect the Philippines and Taiwan to keep their policy rates unchanged. There will be mixed inflation data out of EM Asia, while Vietnam's growth will likely impress. In EMEA, May CPI and Q2 current account is due in South Africa next week. Inflation is likely to have edged up a little by 0.3% MoM. NBH is expected to cut the limit on 3m deposits further while making only slight amendments to its quarterly forecasts. In LatAm, politics will remain at center stage in Brazil. In Colombia, the deterioration of leading activity indicators in April increases risks of a persistent slowdown in 2Q17 and adds downward bias to our economic growth forecast of 2% for 2017.
Next week, there are two key events of focus: (1) the US Treasury semiannual report on FX Policies of Major Trading Partners, and (2) the 19th Party Congress in China. Trade frictions and currency war fears are never far from the radar for Asia, particularly given the region’s large trade surplus with the US. We are not expecting any major shift in the Treasury report, but given the pickup in official intervention in several parts of South Asia, the possibility of an expanded monitoring list cannot be overlooked either. In China, the market will be closely watching the Congress for what it says about leadership over the next decade, and if there are any shifts in government policy, particularly towards deleveraging in the near-term.
Rates: Domestic fundamentals continued to play an important role across local fixed income - from the possibility of rates falling below 7.0% in Brazil, the favorable inflation print in Russia, to a dovish NBP meeting in Poland. Also, except for South Africa, local auctions across EM point to resilient demand. Our top picks remain Russian OFZs - in the belly and the long-end (Mar-33), receivers in PLN (2Y2Y IRS), ILS (3Y1Y), and the short-end of both Brazil (Jul18|Jan19 and Jan19|Jan20) and Colombia (2Y1Y in IBR and Coltes 20s).
FX: A range-bound USD amid subdued yet positive growth and yield pick-up continue to support EM inflows. In LatAm, we favor shorts in EUR/PEN, selling downside in USD/COP, and range-bound BRL (vs. EUR). Buy ARS/MXN. We remain long TRY and ILS vs. USD, but tighten stops (to 3.57 for both) given the strong recent rally and possible USD retracement. We also recommend using the recent spike to sell the less commodity-sensitive EUR/PLN (initial target 4.15), while we maintain our USD/RUB long via options.
Markets have stabilized after last month’s correction, which we think was less about Asia negatives and more about USD positives. The dollar cramped Asia’s style as debate around the Fed chair, hopes for US tax reform, positive data surprises, and stirrings of price pressure caught a positioned market off guard. For the correction to extend, we likely need these US catalysts to develop further (tonight’s US CPI will be watched). There is less cause for concern on the Asian front: risk indicators are unperturbed and the Asian growth picture is constructive with PMIs and exports printing better than expected (see our Economics section). Equity flows are returning on expectations of better 3Q earnings and EM fund flows show commitment to the asset class.
Economics Focus: We expect MAS to maintain its neutral policy stance as Singapore's GDP growth slows slightly in Q3 and exports to improve in other parts of EM Asia. In EMEA, focus on September inflation numbers across CE3, Israel and Egypt. In LatAm, we foresee inflation in Argentina decelerating but not enough to allow the BCRA to begin easing. We also expect Peru’s BCRP to hold rates at 3.50% on reduced growth concerns and already accommodative monetary policy stance.
Rates: The soft CPI number in the US helped receivers across EM. Despite less appealing valuations, we favor front-end receivers in Brazil, extending exposure to 5Y-10Y sector in Colombia, Peru, Chile (vs NDFs) and Mexico (vs US10s). We extend our receivers to 5Y XCCY in Turkey, hold hybrid flatteners in South Africa, short-end RUB swaps and belly receivers in RUB XCCY. Across EMEA low yielders, keep flatteners in Hungary, outright receivers in the belly in Poland and fwd starting IRS receivers in Israel vs Czech.
Strategy Focus: We concentrate our recommendations in highest conviction trades and keep a neutral stance otherwise. The performance over the past week sent both supportive and cautious signals: While markets with better fundamentals partially retraced the more vulnerable remained under pressure despite some USD relief.
Strategy Focus: The recent rise in real rates in the US poses limited risk to EM, in our view. Our main concern is the Fed falling behind the curve, which seems unlikely with contained inflation and a preemptive stance We continue to recommend staying long EM with reduced positions.