Contents
Market Overview
“Blue Wave” to blue mist. All eyes remain fixed on state-level voting, given at the time of writing neither candidate had declared an outright victory. The harbinger of volatility may not have truly materialized, but 10yr and 30yr U.S. Treasuries tightened 10-12bps, which outperformed inflation breakevens, meaning real yields remain firmly below -1% as equities shifted into a higher gear. Markets are working on the assumption that this could become a nirvana for growth and tech stocks. That narrative will be continually challenged into year-end, although the Nasdaq is up 8.6% on the week, while the Dow and S&P are up 6.8-7.0%. U.S. equities marginally outperformed EM equities, but Chinese stocks kept up pace despite the postponed Ant Group IPO knocking Alibaba. The FOMC was on hand to provide a backstop, although little in Powell’s language changed, meaning Average Inflation Targeting developments are saved for December, but monthly asset purchases of $120bn are set to continue. The wave of COVID-19 lockdowns may be extending across Europe, which lent on crude markets on Monday, although quickly receded with Brent and WTI ending up 5.2-6.5% on the week. Speaking of COVID-19 lockdowns, England entered a four-week restriction, although the BoE quickly ramped up QE by £150bn taking the bond buying program to £895bn, while also extending the furlough scheme to the end of March (covering 1Q21 Brexit uncertainty). Over in EM, sovereign credit gained 2.6% with spreads 24bps tighter. We saw Lebanon, Sri Lanka and Zambia outperform, as Belize, Ethiopia and Tajikistan lagged. Meanwhile, Turkey hiked the one-week swap rate for a third time in seven weeks, in line with our expectations from the last EM Weekly publication, but the inflation print sent the lira into a spin. With EURTRY touching 10 and USDTRY breaking 8.50, the lira has now become the worst performing EMFX in 2020, overtaking the Brazilian real. The next question is whether the CBRT deliver an emergency one-week repo hike before the next MPC meeting on November 19th. The next immediate event is current account data and the extent to which Turkey will register a deficit. Other events include inflation out of China, Czech Republic, India and Romania. China will also release M2 growth (circa 10.9%) with new loans set to reduce to RMB900bn in October. We can also expect GDP prints out of Malaysia and Philippines. Rate decisions out of Egypt, Hungary and Peru ought to be benign with rates unchanged, but Mexico may cut. There is also an expectation that Zambia will default on its 2024 eurobond after failing to pay interest within the four-week grace period. Beyond that, the IMF and World Bank have now postponed meetings in Marrakech to October 2022 due to the COVID-19 pandemic.
Fixed Income
Equities
Commodities
Source for data tables: Bloomberg, JPMorgan, Gramercy. EM Fixed Income is represented by the following JPMorgan Indicies: EMBI Global, GBI-EM Global Diversified, CEMBI Broad Diversified and CEMBI Broad High Yield. DM Fixed Income is represented by the JPMorgan JULI Total Return Index and Domestic High Yield Index. Fixed Income, Equity and Commodity data is as of November 6, 2020 (Mid Afternoon).
Emerging Markets Weekly Highlights
Emerging Markets assets react positively to presumed U.S. election outcomes despite lingering uncertainties, The Turkish lira remains under pressure as the authorities continue to resist implementing forceful policy measures, Argentina achieves reprieve from FX pressure in the black market, and Peru’s Congress proceeds with impeachment of President Martin Vizcarra.
Emerging Markets assets react positively to presumed U.S. election outcomes despite lingering uncertainties
Event: A risk-on sentiment prevailed across EM assets as counting of votes in several key battleground states continued days after the November 3rd U.S. election. Although not final, the most recent results point to a divided government with a Democratic administration and Republican-controlled Senate. Meanwhile, President Trump’s campaign has signaled plans to challenge results in the courts and demand recounts, which suggests that declaring a final winner in the presidential race might take longer than expected.
Gramercy commentary: The dominant market narrative heading into Election Day on November 3rd was that a “Blue Wave” scenario, i.e. the Democrats in control of both the White House and Congress, would be the most favorable outcome for EM assets. This view was anchored by expectations that a massive ($2-3 trillion) new fiscal stimulus will materialize in the early days of a Biden Administration not constrained by quid-pro-quo negotiations with the legislative branch, which would provide a major boost to GDP growth as the economy attempts to rebound from the COVID-19 shock. Given that the Republicans appear set to retain control of the Senate, the scenario that markets are now facing is one of a split government and likely significant policy gridlock. This signals to us that any potential fiscal package next year will be smaller in size and could take longer to materialize against a backdrop of likely additional economic damage over the coming months as the pandemic resurges during fall/winter in the northern hemisphere. Despite diminished prospects of an economic boost via the fiscal channel, the initial market reaction to the U.S. election developments suggests that investors have quickly shifted to “a gridlock = goldilocks” narrative. A divided government in D.C. is seen as a safeguard against radical economic policy changes related to taxation and regulation, while the “Fed Put” remains intact amid low/non-existent inflationary pressures given lower expected fiscal impulse. While we agree that such a backdrop might support U.S. assets, especially equities, we are not sure the same is entirely true for emerging markets. For example, amid a difficult gradual recovery from the massive exogenous economic shock due to the pandemic, economies across EM would have benefited in 2021 from positive spillover effects of a very large fiscal stimulus (and a weaker USD) in the world’s largest economy which now appears unlikely. In addition, the risk of a prolonged period of elevated global uncertainty due to a “contested elections” scenario in the U.S. remains non-negligible in our opinion, which could challenge the constructive market read-through thus far, disrupting the risk-on environment in the near term.
The Turkish lira remains under pressure as the authorities continue to resist implementing forceful policy measures
Event: Turkey’s currency (TRY) underperformed peers amid the general risk-on tone in EM post-U.S. elections, despite already significant accumulated depreciation since August.
Gramercy commentary: The main issue weighing on Turkey’s credit story in general and TRY in particular, is a policy mix characterized by excessively easy monetary and financial conditions, which leads to numerous macro imbalances and erodes policy credibility. Unanchored inflation expectations and low/negative interest rates feed into TRY weakness, which in turn fuels further inflation, creating a vicious cycle that can only be broken by a credibility shock, in our opinion. A decisive tightening of monetary policy via the 1-week repo rate (i.e. the Central Bank’s (CBRT) main policy rate) would provide the credibility shock and rebuild market confidence similar to the previous episode of sustained material currency weakness that took place in the summer of 2018. However, the authorities remain reluctant to deliver such a policy action, constrained by political considerations and eager to support economic activity amid the fallout from the pandemic. In addition to a sub-optimal policy mix from a market perspective, ever-present geopolitical risks, including the threat of U.S. sanctions, create further pressure points for Turkish assets and complicate the vicious cycle dilemma described above. Meanwhile, the CBRT has delivered meaningful “backdoor tightening” of around 600bps since July by managing the cost of onshore liquidity that it provides, but even these efforts have not helped the TRY as inflation expectations have adjusted higher, keeping forward looking real interest rates around 0%. Historically, domestic real interest rates of around 3% have been required to compel residents to take profits on long FX positions and switch back into lira deposits, alleviating pressure on the TRY. From that perspective, we believe that in order to stabilize the currency the CBRT will need to deliver a “headline” rate hike of at least 500bps accompanied by credible forward guidance to reassure investors and savers, provided there is no material escalation in geopolitical risks in the meantime. In the absence of a credibility shock in the near future, we expect investors to maintain a generally cautious attitude toward Turkish assets despite cheaper valuations and the USDTRY to continue on a weakening trajectory into year-end, potentially raising concerns about currency mismatches on corporate balance sheets.
Argentina achieves reprieve from FX pressure in the black market
Event: The parallel FX rates reversed course after several weeks of depreciation with the blue chip swap rate dropping back to around 150 pesos per dollar from a high of over 180 pesos per dollar. This follows the issuance of dollar linked debt as well as guidance to reduce reliance on central bank financing of the deficit. Meanwhile, the 2021 budget was discussed in Congress in aim for approval ahead of the IMF mission’s arrival next week.
Gramercy commentary: The authorities’ realization that further targeted and pragmatic measures were needed to reduce the gap between official and parallel FX rates is on the margin positive for financial stability and market sentiment. However, more will likely be needed to sustain the trend as net FX reserves have dropped into negative territory. Most importantly, a concrete medium term macroeconomic plan which entails a credible path to fiscal consolidation and sustainable economic recovery in order to more materially boost confidence, increase peso demand, and in turn lower domestic interest rates over time is crucial for greater stability and FX reserve recovery. The current budget does yet provide this albeit local reports indicate there are plans underway to potentially achieve a narrower primary deficit than the currently outlined 4.5% of GDP for next year. Further details on how this would be achieved is key to determining the likelihood of meeting such a target. The broader macroeconomic agenda should be a central aspect of the upcoming discussions with the Fund albeit unclear how much clarity outside observers will be privy to throughout the negotiation process. Regardless, we continue to expect an eventual agreement with the IMF to be reached with the extent of support to confidence and bond prices dependent on the components of the deal (size, tenor, conditionality etc.).
Peru’s Congress proceeds with impeachment of President Martin Vizcarra
Events: This week, Peru’s Congress voted in favor of impeaching President Vizcarra for alleged “moral incapacity” related to bribery and corruption. The impeachment motion, based on alleged acts of corruption in 2014 when Vizcarra was a governor in Southern Peru, was approved by 60 votes to 40 with 18 abstentions. This is the second impeachment trial Vizcarra has faced in two months. The trial is scheduled for November 9th.
Gramercy commentary: Our base case continues to be that there are unlikely enough votes to remove Vizcarra from office. To do so, Congress requires 87 of 130 total votes (2/3 approval) after next week’s hearing. Even if all abstentions voted in favor, they would still fall short of the support needed to impeach him. Furthermore, Vizcarra cannot run in the upcoming general election in April 2021 and legal merits of the impeachment remain in question. However, his removal from office cannot be ruled out given the highly fluid nature of the current political and economic backdrop. Regardless, the impeachment proceedings signal political instability will continue to complicate domestic policymaking efforts in the run-up to the election, particularly with respect to COVID-19 and the country’s economic recovery. For markets, there are a few concerns regarding Peru. First, if political instability in the medium-term will hinder Peru’s economic recovery from COVID-19, despite its relatively strong fundamentals upon entering the crisis. Second, if policymakers favor more populist policies, that could weaken Peru’s investment grade credit profile. Relatedly, domestic pension reform has the potential to create structural implications for local market sentiment and liquidity over time. Earlier this week, Congress approved a new round of private pension fund withdrawals, allowing those suffering joblessness during COVID-19 to use pension savings for support. While still measured in nature with estimated withdrawals of ~PEN 15bn vs. total private pension system AUM of ~PEN 155bn, the central bank may need to intervene to stem volatility. Over the medium-term, evolution of policy, which allows for larger withdrawals in the context of less robust macro policy, could create greater volatility and begin to erode confidence in Peru’s still partially dollarized financial system.
Emerging Markets Technicals
Emerging Markets Flows
Source for graphs: Bloomberg, JPMorgan, Gramercy. As of November 6, 2020.
COVID Resources
Emerging Markets COVID-19 Case Summary
COVID-19: An analysis of the increase of the pandemic’s severity
Overall, the virus continues to undergo a material resurgence in most developed markets. In Europe, cases are spiking to record levels and while this new wave has had much lower hospitalization rates than the first one relative to cases (10x lower hospitalization rates), total case counts are significantly higher than in the first wave. As such, hospitalizations, though generally lower than in April/May are trending upwards at alarming rates, and in France, hospitalization rates are at 66% of peak levels. In terms of mobility and policy stringency, we see a continued trend across Europe of reduced mobility and increased lockdowns (not quite to same extent as in April/May but significantly higher restrictions than over the summer). In the U.S., the trend is lagging Europe, with spiking cases, mounting hospitalizations and already signs of reduced mobility and increased lockdowns.
In emerging markets, Latin America’s first wave of the virus is finally waning down, with a reduction in cases and hospitalizations in most countries. Mobility for the region is also on the rise (though it remains 30 to 40% below benchmarks levels) and policy stringency is slightly loosening.
Going ahead, it will be key to monitor the evolution of the situation in Europe following this new series of lockdowns, both in terms of virus containment and economic repercussions, as those takeaways are likely to influence the policy path forward in the U.S. and the rest of the world.
New cases per week are at an all-time high and continue trending upwards, driven by a resurgence in DMs with still high rates in EMs.
Source: Ourworldindata.org.
New deaths per week are about 35% below peak levels and the trend remains upwards sloping (vs 40% below peak levels a month ago).
Source: Ourworldindata.org.
In Europe, though hospitalization rates (in % of cases) are lower, total cases are significantly higher than in 1st wave.
Source: Ourworldindata.org. European Center for Disease Prevention and Control.
Source: Worldometer as of November 6, 2020.
Additional Crisis Resources:
Johns Hopkins COVID-19 Case Tracker
For questions, please contact:
Kathryn Exum, Senior Vice President, Sovereign Research Analyst, [email protected]
Petar Atanasov, Senior Vice President, Sovereign Research Analyst, [email protected]
Tolu Alamutu, Senior Vice President, Corporate Research Analyst, [email protected]
James Barry, Vice President, Corporate Research Analyst, [email protected]
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