Welcome to the inaugural edition of our new bi-weekly publication, The Intelligence Report (TIR).
As we enter 2017, investors continue to focus on the implications of Donald Trump’s unexpected victory in the U.S. elections. Hopes for deregulation, infrastructure spending and tax cuts have acted as an accelerant to a reflation theme which had already been kindled by the slow, but broad-based, normalisation of growth and inflation evident in global economic data and leading indicators since the summer. Developed markets have reflected this reflation theme as equities have strengthened, credit spreads have tightened, inflation expectations have risen, the U.S. dollar has rallied and core government bond yield curves have steepened bearishly. The reaction of emerging markets, however, has been more nuanced. Reflation and Trumpenomics impact emerging markets through several channels; higher U.S. rates and a stronger U.S. dollar pressure countries with large external financing requirements, the threat of protectionism weighs on emerging market countries with open economies and strong trade links with the U.S. , while infrastructure spending and stronger global growth support commodity prices. These factors affect developing countries differently, both on a relative basis and in absolute terms, a phenomenon popularly labelled as the “good EM/bad EM” market theme. In this paradigm, Mexico is widely seen to be vulnerable to the U.S. protectionism threat given that its exports to the United States represent 28% of GDP. Turkey is similarly pressured by higher U.S. rates and stronger commodity price prospects given its large external financing requirements and absence of natural resources. By contrast, Brazil’s basic balance surplus, relatively closed but resource-rich economy and high interest rates imply that it is relatively protected in this environment. Russia is often seen as a beneficiary in absolute, as well as relative terms given its strong external balances, sensitivity to higher oil prices and expectations of a more sympathetic stance from the new Administration.
Given the richly nuanced outlook for emerging markets in 2017, we have highlighted two striking events of the year so far – the continued pronounced weakness of Mexican assets (ten-year government bond yields have risen by 150 basis points since the U.S. elections, and the Mexican peso has fallen by 15% to new all-time lows in recent days), and the unexpectedly large reduction in official rates in Brazil last week. In the first article, Hardeep Dogra and Bryan Carter address the issue of whether Mexican asset valuations are now cheap, and what catalysts could reverse this pronounced bear move. In the second article, Patrick Mange addresses the possibility that the Brazilian central bank rate cut last week signals the start of a more aggressive monetary easing cycle, and the implications for asset markets.Download to read more