Sunday 12, March 2017 by Jessica Combes

Bank of America Merrill Lynch: Global Emerging Markets Weekly report

Bank of America Merrill Lynch (BofAML) shares its medium-term views.


span style="font-family: Calibri; font-size: small;">Key Highlights

  • Brent is likely to be down about $10 on a 20 per cent BAT, and this time in a supply shock, exacerbating the impact on producers.
  • The USD/SAR points have come in a lot: eg, 12-month is now at 180 vs 600 in November 2016 when Brent was $10 lower than today.
  • Even in a tail-risk scenario, BofA Merrill Lynch expect Saudi Arabia to hold the peg for years to come, but the forwards would certainly move.


GEM themes
BofAML took a break from its structural EM bullishness because spreads are considered to be too tight ahead of the major uncertainty around US tax reform and French elections in April. However, BofAML would buy the dip spreads are expected to revisit their 2012 lows. EM remains supported by improving data, rising commodity prices and strong equity sentiment in the US. Focus on relative value, short duration and idiosyncratic trades.

The Republican clean sweep is likely to reinforce USD strength against Asian FX due to:
1) a policy mix driving higher US real rates; and
2) uncertainty around trade protectionism that is detrimental to Asia’s growth.
Steeper fixed income curves are expected, as the front end should remain anchored while the belly and back end should sell off in tandem with global yields. In FX, BofAML is biased towards stronger USD against TWD and like long INR vs SGD on relative value basis.

br /> EEMEA
Russia remains fundamentally strongest, but positioning is crowded, and the authorities are capping RUB strength. Equities are most favoured as well as buying FX and credit on weakness. Turkey EXD remains relatively cheap but BofAML has taken profit on its OW recommendation given the rising global risks; local assets remain too volatile.

In South Africa, BofAML will wait for better levels to buy FX, but 10y bonds offer better risk/reward; it is long protection as a hedge. In CEE, rising inflation is a theme, and the longer-term outlook remains for stronger FX and higher rates. Hedge European concerns with HUF shorts vs PLN or via OTM puts.

br /> LatAm
Despite some recent stabilisation in US rates, we expect higher real rates are expected in developed markets. As policy uncertainty remains, weaker LatAm currencies vs USD are expected and a bear steepening in LatAm curves. It is likely that MXN and BRL to remain volatile, while PEN and CLP and ARS to a lower extent are more resilient, driven by local dynamics. The fundamental case for lower rates in Brazil and Argentina is likely still in place. BofAML remains receiving rates in the belly of the curve in Brazil, but closed its receivers in Argentina. BofAML likes the long end of the Soberanos curve, steepeners in the long end of Mexico and Colombia, as well as payers in the front end of Colombia’s curve.

EEMEA Economics

Russia: making history in inflation

BofAML cut CPI to 3.6 per cent yoy in 2017E eop and four per cent average due to a much weaker than expected 2M17, which should keep inflation below four per cent for a large part of the year.

Deflation in momsa terms could allow the CBR to cuts rates in April, but the CBR should first change its guidance in the new macro forecast for the March meeting. 

BofAML cut its inflation outlook in Russia to 3.6 per cent in 2017 eop and to four per cent on average for the year, down from the previous expectations of 3.9 per cent and 4.5 per cent, respectively. Based on these figures inflation could hit the CBR’s four per cent target in June, vs the earlier call of 3Q17. Achievement of the four per cent target should be a sufficient trigger for a 50bp cut in June, BofAML’s baseline view, and a cumulative 150bp this year, unless continued positive news flow forces a cut in April. The review on the macro forecasts for the March policy meeting gives the CBR a good opportunity to change guidance and signal earlier action. 

Record-low 1Q17 inflation is the trigger for the revision

RosStat has just confirmed a weak 0.2 per cent mom CPI release for February, which has pushed inflation down to 4.6 per cent yoy for the month. The slowdown was broad-based with all CPI components slowing. However, most importantly, core CPI growth also weakened to 0.2 per cent mom, which has pushed core inflation down to 5 per cent yoy for the month. At 5 per cent, core inflation is at an all-time low in modern Russian history. This seems to highlight that the slowdown is fundamental and not driven by one-off factors like annual indexations or a lack of such. As weekly data so far give no indication of a reversal of this strong disinflation trend, we think such a slowdown will likely keep inflation at a much lower level for the remainder of the year. 

How about deflation risks?

In seasonally adjusted terms, both headline and core inflation in Russia moved into negative growth territory in January-February. It should be emphasised that such deflation in seasonally adjusted terms for two consecutive months is first in reported Russian history and is driven by food and non-food deflation. This differentiates this instance of deflation from technical CPI momsa declines in January 2012 on the back of the delay in the indexation of regulated tariffs starting from 2012. Moreover, core and non-food deflation in momsa terms is also the first reported instance in Russian history. 

This might suggest that this deflationary trend could be fundamental in nature. After years of fiscal consolidation, stagnation of disposable incomes and deleveraging, considerable weakness in inflationary pressures should not be surprising. However, this trend could pose further downside risks even to our new inflation outlook, should it be sustained over the next several months. 

Start of consumer recovery should keep prices rising

The latest CBR report Talking Trends suggests that elevated inflationary expectations and persistent wage growth remain risks to the four per cent target. Risks to the target are not a concern, but do believe that such momsa deflation will be temporary.

With renewed real disposable income growth from January 2017, consumer spending should resume growth in 1Q17. Although it is likely that this would not be sufficient to support major inflationary risks, it should help to keep price growth in positive territory. However, this view could be tested in the coming weeks should the current weakness of inflationary pressures persist. 

Strong RUB helps, but does not seem to be the key driver

Part of the recent disinflation can be attributed to the considerable strength of the RUB over the past several weeks. However, we do not believe that this is an important driver and even the potential inflationary impact of possible RUB weakness later in the year will likely be limited. Inflationary pass-through from RUB volatility has declined since 2014 and remains quite limited. Even though the RUB hit all-time lows in early 2016, it did not trigger any major pick-up of headline inflation in 1Q16, but might have supported moderate reflation in 2Q16-3Q16. At the same time, appreciation so far remains relatively modest, at least relative to recent history. All of this, we think, seems to suggest that disinflation is largely driven by underlying weakness in fundamental demand, rather than by technicals.

March forecast as a signal for April cut

The CBR’s hawkish guidance means it will likely continue to keep rates on hold until at least June. However, the upcoming review of the CBR’s macro forecasts for the March meeting could present a good opportunity for it to turn more dovish in light of the recent data. In particular, the likely revision of oil price assumptions for this year from the current $40/bbl would push the CBR’s baseline view closer to its own “optimistic scenario” with accelerated rate cuts. Inflationary expectations, which at the

moment appear to be in the focus of the CBR’s attention have also been on quite a benign declining trend despite stabilisation in February.


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