Emerging Markets Explorer - SEB Group · Our outlook for Emerging Market (EM) assets, in particular...

Emerging Markets ExplorerEM Liftoff on US Fed Hike

March 2015

Strategy — Get Ready for EM Catch Up Macro — Global Economic Recovery Watch — The Fed

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Emerging Markets Explorer

CONTENTS

Executive Summary................................................................................................................................................................................... 3

SEB EM Forecasts and Track Record ...................................................................................................................................................... 4

Macro Overview: Liftoff in EM Assets to Follow US Rate Hike ............................................................................................................ 5

Theme: China — Focus on the Currency, Not Interest Rates ............................................................................................................ 10

Two Scenarios ...................................................................................................................................................................................... 11 Theme: Effects of Lower Oil Prices ........................................................................................................................................................ 13

Strategy: Based on Medium-term EM Strength ....................................................................................................................................15

Trading Recommendations ................................................................................................................................................................15 Fixed Income: Diverging Dynamics ...................................................................................................................................................15

Election Monitor ...................................................................................................................................................................................... 18

Country Section ....................................................................................................................................................................................... 19

Asia ............................................................................................................................................................................................................ 19

China .................................................................................................................................................................................................... 19 Hong Kong ........................................................................................................................................................................................... 19 India ...................................................................................................................................................................................................... 19 Indonesia ............................................................................................................................................................................................. 20 South Korea ......................................................................................................................................................................................... 20 Malaysia ............................................................................................................................................................................................... 20 Philippines ........................................................................................................................................................................................... 21 Singapore ............................................................................................................................................................................................. 21 Taiwan .................................................................................................................................................................................................. 21 Thailand ............................................................................................................................................................................................... 21

Emerging Europe ..................................................................................................................................................................................... 22

Czech Republic ................................................................................................................................................................................... 22 Hungary ............................................................................................................................................................................................... 22 Poland .................................................................................................................................................................................................. 23 Romania ............................................................................................................................................................................................... 24 Russia ................................................................................................................................................................................................... 24 Turkey .................................................................................................................................................................................................. 25 Ukraine ................................................................................................................................................................................................. 26

Latin America ........................................................................................................................................................................................... 26

Brazil ..................................................................................................................................................................................................... 26 Chile ...................................................................................................................................................................................................... 27 Mexico .................................................................................................................................................................................................. 28

Sub-Saharan Africa ................................................................................................................................................................................. 29

Botswana ............................................................................................................................................................................................. 29 Ghana ................................................................................................................................................................................................... 29 Kenya .................................................................................................................................................................................................... 29 Nigeria .................................................................................................................................................................................................. 30 South Africa ......................................................................................................................................................................................... 30

Disclaimer ................................................................................................................................................................................................. 32

Contacts ................................................................................................................................................................................................... 33

EDITOR

Per Hammarlund

CONTRIBUTORS

Olle Holmgren

Andreas Johnson

Magnus Lilja

Peiqian Liu

Dennis Masich

Dag Müller

Fredrik Skoglund

Anders Söderberg

Louise Valentin

Sean Yokota

Disclaimer: See page 32

Contacts: See page 33

Cut-off date: 12 March, 2015

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Executive Summary

TRADE RECOMMENDATIONS (MORE ON P. 15)

USD/MXN Look to sell USD/MXN

on US Fed Rate hike

USD/RUB Look to sell USD/RUB at 65.0

for move to 57.0

EUR/CEE4Look to sell EUR vs

PLN, RON, and HUF

USD/Asia Go long USD vs CNY, AUD,

MYR, SGD, and THB

MACRO OVERVIEW

Our outlook for Emerging Market (EM) assets, in particular EM currencies and equities, is cautiously optimistic, primarily for

three reasons. First, economic weakness in the euro zone appears to have bottomed out. Although it will not be stellar, we

expect real GDP growth to accelerate slightly from 1.0% in 2014 to 1.2% in 2015. Second, the US economy is gaining

momentum, and looks set to expand by 3.5% in 2015. Third, we believe that China will continue to deliver strong, albeit moderating growth of 7.0% in 2015.

While EM assets will suffer during the first half of the year, and potentially into the third quarter due to uncertainty over the

timing and pace of the US Fed monetary policy tightening and the effects of ECB quantitative easing, especially on Central

and Eastern Europe (CEE), an improvement in the global economic outlook will support EM assets in the latter part of the

year. However, there will be important exceptions, and differentiation among countries will be crucial. Countries such as

Brazil and Turkey look particularly vulnerable, while countries with strong fundamentals and ties to the US and Chinese economies look set to benefit. After years of sub-par returns on EM investments, it is time to get ready for re-entry.

THEMES

Market’s attention has been on China’s monetary easing where the central bank (PBoC) has delivered 2 interest rate cuts

after 2 years on hold. Most China analysts including SEB expect more to follow. Monetary easing has been an ongoing trend

for the last 12 months. Instead of interest rates, investors should focus on the recent change in foreign exchange policy. We

are starting to see the central bank’s behaviour shifting to allow USD/CNY fixing to rise (i.e., weaken CNY vs USD). In addition

to shorting CNY vs USD, we think the best way to invest would be to continue to be short commodities and the Australian Dollar (AUD), or in Asia to be short the Malaysian Ringgit (MYR) or Singapore Dollar (SGD).

Since July 2014, oil prices have fallen by some 50% from USD 110-115 per barrel to current levels around USD 60. The price

fall has been driven by a combination of factors. Increasing supply is one explanation. At the same time, demand growth in

China and Europe has moderated and contributed to the downturn. Oil price downturns are usually positive for the world

economy and global GDP growth. However, country-specific effects vary widely. The big winners will be economies that are

heavy users of energy and dependent on oil imports. Taking a look at the BRIC economies and Turkey reveals that there are two clear winners (India and Turkey), one obvious loser (Russia) and two economies where effects will be limited.

STRATEGY

Monetary policy is being eased in key Asian economies. In addition to shorting CNY vs USD, we think the best way to invest

would be to continue to be short commodities and the Australian dollar (AUD), or in Asia to be short the Malaysian ringgit

(MYR), Singapore dollar (SGD), or Thai baht (THB). The Mexican peso is currently under pressure due to the low oil price and

concerns over corruption involving both President Nieto and Finance Minister Videgaray. However, fundamentals are good

and MXN will benefit from the US economic recovery as well as a gradual increase in the price of oil in 2H’15. The Russian ruble (RUB) will continue to trade with oil, and we recommend buying RUB when we see a sustainable rise in oil prices.

In our fixed income portfolio, we are increasing the weight in Hungary, given a potential upgrade of the country’s rating. We

are pulling Turkey to market weight, after the political turmoil surrounding the central bank. We are going underweight in

South Africa, due to a potential downgrade. And, finally, in Poland, we are going slightly underweight, after the central bank

signalled that the rate cutting cycle may be over. The bonds were looking rather expensive, even pre-announcement.

However, we are keeping our overweight positions in Russia, Brazil and Mexico. We still believe that EM FX is currently looking very cheap and it is likely to perform well post the initial US rate hike.

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SEB EM Forecasts and Track Record

SEB EM FX Forecasts (end of period) SEB EM Policy Rate Forecasts (end of period)12-Mar-2015 Spot 2Q-15 3Q-15 4Q-15 1Q-16 4Q-16 12-Mar-2015 1Q-15 2Q-15 3Q-15 4Q-15 1Q-16

vs. EUR Asia

PLN 4.15 4.20 4.15 4.07 4.05 3.90 China lending 5.35 5.35 5.00 4.75 4.75 4.75

HUF 305 311 309 302 300 290 China deposit 2.50 2.50 2.25 2.00 2.00 2.00

CZK 27.3 27.5 27.5 27.5 27.5 25.5 China RRR 19.50 19.50 19.00 18.50 18.00 18.00

RON 4.45 4.50 4.45 4.39 4.30 4.15 Korea 2.00 1.75 1.50 1.50 1.50 1.50

TRY 2.75 2.84 2.85 2.86 2.85 3.00 India 7.50 7.50 7.25 7.00 7.00 7.00

RUB 64.8 70.4 61.8 56.1 53.0 50.0 Indonesia 7.50 7.50 7.25 7.25 7.25 7.25

RUB BASKET 62.9 68.5 60.8 55.5 53.0 50.0 Malaysia 3.25 3.25 3.25 3.25 3.50 3.50

vs. USD Philippines 4.00 4.00 4.00 4.00 4.00 4.00

RUB 61.3 67.0 60.0 55.0 53.0 50.0 Thailand 1.75 1.75 1.50 1.50 1.50 1.50

TRY 2.59 2.70 2.77 2.80 2.85 3.00 Taiwan 1.88 1.88 1.88 1.88 2.00 2.00

PLN 3.92 4.00 4.03 3.99 4.05 3.90 Emerging Europe

HUF 288 296 300 296 300 290 Poland 1.50 1.50 1.50 1.50 1.75 2.00

CZK 25.8 26.2 26.7 27.0 27.5 25.5 Czech 0.05 0.05 0.05 0.05 0.05 0.25

UAH 21.67 30.00 30.00 30.00 30.00 30.00 Hungary 2.10 1.90 1.60 1.60 2.00 2.50

ZAR 12.35 11.95 12.20 12.50 12.70 13.00 Turkey 1W repo 7.50 7.50 7.50 7.75 9.00 10.00

KES 91.8 92.0 93.0 94.0 95.0 Turkey O/N borrowing 7.25 7.25 7.25 7.25 7.50 8.00

NGN 199 200 200 200 200 Turkey O/N lending 10.75 10.75 10.75 11.00 11.50 12.00

BRL 3.17 3.20 3.30 3.40 3.45 3.80 Romania 2.25 2.00 2.00 2.00 2.25 2.50

MXN 15.44 14.70 14.40 14.10 14.00 13.00 Russia Key Rate 15.00 13.00 10.00 8.00 8.00 8.00

CLP 633 650 660 670 670 580 Ukraine 30.00 30.00 30.00 30.00 20.00 20.00

CNY 6.26 6.35 6.25 6.20 6.25 6.10 Latin America

CNH 6.27 6.35 6.25 6.20 6.25 6.10 Brazil 12.75 12.75 13.25 13.50 14.00 14.00

HKD 7.76 7.80 7.80 7.80 7.80 7.80 Chile 3.00 3.00 3.00 3.00 3.50 3.75

IDR 13,189 13,500 13,000 12,800 12,800 12,500 Mexico 3.00 3.00 3.00 3.50 3.75 4.00

INR 62.7 64.0 63.0 60.0 60.0 56.0 Sub-Saharan Africa

KRW 1,129 1,140 1,130 1,110 1,110 1,050 S. Africa 5.75 5.75 5.75 6.00 6.25 6.75

MYR 3.69 3.73 3.70 3.65 3.67 3.35 Nigeria 13.00 13.00 13.00 13.00 13.00 13.00

PHP 44.3 45.5 44.0 43.0 43.0 41.0 Kenya 8.50 8.50 9.00 9.00 9.00 9.00

SGD 1.39 1.40 1.38 1.37 1.38 1.30 Source: Bloomberg, SEB

THB 32.8 35.0 34.5 34.0 34.0 33.0

TWD 31.6 32.7 32.5 32.3 32.5 30.5

EUR/USD 1.06 1.03 1.02 1.00 1.00 1.00

USD/JPY 121.4 125 128 130 135 140

EUR/SEK 9.07 9.40 9.10 9.00 9.00 9.00

USD/SEK 8.54 9.13 8.92 9.00 9.00 9.00

SEB Real GDP Forecasts EM FX Recommendations: Track Record2011 2012 2013 2014 2015 2016 # of recommendations Hit Ratio P&L

SEB EM Aggregate 7.4 6.4 4.9 4.8 4.7 4.9 2008 11 72.7% 22.8%

Asia 2009 14 50.0% 10.4%

China 9.3 7.7 7.7 7.4 7.0 6.7 2010 11 54.5% 19.5%

India 6.5 4.4 4.6 5.3 7.3 7.6 2011 8 50.0% 17.8%

Indonesia 6.5 6.3 5.8 5.0 5.4 5.7 2012 12 58.3% 4.0%

South Korea 3.7 2.3 3.0 3.3 3.5 3.5 2013 8 50.0% 1.2%

Singapore 6.2 3.4 4.4 2.9 3.2 3.6 2014 7 42.9% -4.3%

Philippines 3.6 6.8 7.2 6.1 6.2 6.3 Total 71 54.9% 71.4%

Malaysia 5.4 6.5 5.1 5.8 5.2 5.3 Average P&L per year 2008-2014 10.2%

Hong Kong 2.9 2.9 2.9 2.4 3.1 3.5 Average P&L per recommendation 2008-2014 1.00%

Thailand 0.1 6.5 2.9 0.8 3.5 3.7

Emerging Europe

Poland 4.8 1.8 1.7 3.3 3.0 3.4

Czech Republic 1.0 -1.4 1.1 1.3 2.4 2.9

Hungary 1.3 -2.7 3.2 3.4 2.5 2.4

Turkey 5.3 1.3 4.5 1.7 3.3 4.2

Romania 2.3 0.6 3.5 2.6 3.0 3.3

Russia 4.3 3.4 1.3 0.6 -5.5 -1.0

Ukraine 5.2 0.3 0.0 -6.5 -5.0 0.0

Latin America

Brazil 1.4 1.8 2.2 -0.2 -0.5 1.5

Chile 5.8 5.5 4.2 1.6 2..5 3.8

Mexico 4.3 3.6 1.1 2.2 3.3 4.0

Sub-Saharan Africa

South Africa 3.3 1.8 2.9 1.4 2.2 2.3

Nigeria 16.2 12.6 12.6 6.5 5.0 7.0

Kenya 4.8 5.1 4.1 5.0 5.8 6.0Source: IMF, OECD, Bloomberg, SEB

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Macro Overview: Liftoff in EM Assets to Follow US Rate Hike

Our outlook for Emerging Market (EM) assets, in particular

EM currencies and equities, is cautiously optimistic,

primarily for three reasons. First, economic weakness in the

euro zone appears to have bottomed out. Although it will

not be stellar, we expect real GDP growth to accelerate

slightly from 1.0% in 2014 to 1.2% in 2015. Second, the US

economy is gaining momentum, and looks set to expand by

3.5% in 2015. Third, we believe that China will continue to

deliver strong, albeit moderating growth of 7.0% in 2015 and 6.7% in 2016.

While EM assets will suffer during the first half of the year,

and potentially into the third quarter due to uncertainty

over the timing and pace of the US Fed monetary policy

tightening and the effects of ECB quantitative easing,

especially on Central and Eastern Europe (CEE), the

improvement in the global economic outlook will support

EM assets in the latter part of the year. However, there will

be important exceptions, and differentiation among

countries will be important. Countries such as Brazil and

Turkey look particularly vulnerable, while countries with

strong fundamentals and ties to the US and Chinese

economies look set to benefit. We expect the CEE 4 (Czech,

Hungary, Poland, and Romania) currencies to weaken hand

in hand with the EUR against the USD in the first half of the

year, but to strengthen slowly as growth picks up and

convergence with the richer EU economies resumes in the

second half. After years of sub-par returns on EM investments, it is time to get ready for re-entry.

BRIGHTENING GLOBAL OUTLOOK

EM currencies have taken a severe beating since 2011.

While the weakness is partly a result of USD strength, that is

not the whole story. On an aggregate level, EM currencies

are now weaker than they were during the global financial

crisis and the last period of exceptional USD strength in

2001–2002. We think that level of gloom in EM is not justified.

Despite renewed political uncertainty regarding a potential

Greek exit from the euro zone, weakness among the EU

economies appear to have bottomed out. Importantly for

the CEE economies, there are signs of a gradual

improvement in Germany, further boosted by expectations

that German exports will benefit from the depreciation of

the EUR. We do not expect that Greece will choose to leave

the euro zone, or that it will be forced out. Forcing Greece to

leave would probably do more damage than good to the EU

by calling into question the commitment to hold the EMU

together should one of the large economies such as Spain

or Italy face renewed financial market pressure. In any case,

while the risk of a Greek exit should not be ignored,

contagion risks should be smaller and more manageable now than they appeared in 2011.

Growth in the EU will be far from spectacular. Yet, the CEE 4

are highly integrated with the German economy, serving as

suppliers to the German export sector. With German

consumer and business sentiment rising gradually along

with exports, the CEE 4 will benefit on the back of good

economic fundamentals. While their currencies may weaken

somewhat versus the USD, rising money market rates and stock markets should more than compensate for that.

More importantly for the global economy is that the US

economy is picking up steam. Although the US is not as

commodity hungry as China, rising growth in the world’s

largest economy will eventually lift expectations for EM too.

A steady strengthening of the US labour market along with

rising real wages and improving consumer and business

sentiment provide fertile ground for consumer-led growth

in the coming years. Lower gasoline prices and a wealth

effect from rising home prices will also support

consumption. In addition, slack is being reduced, which

together with rising demand should boost capital spending.

In sum, we see broad-based growth picking up in the US over the coming years.

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The world’s second largest economy, China, will slow, but

grow by a still strong 7.0% this year. The reorientation away

from investment- and export-led growth to consumption

and services will dampen commodity demand growth and

weigh on economic sentiment primarily in commodity-

dependent countries in Latin America and Africa. However,

rising per capita income and consumption in China will

benefit Asia generally, although some higher-value-added

sectors in countries such as Korea and Japan will likely see rising competition from Chinese companies.

INFLATION TO RISE IN THE SECOND HALF 2015

We expect the first half of the year to be challenging for EM.

The main reason is uncertainty about the timing and pace

of US monetary policy tightening. The USD appreciation

looks stretched on a short-term technical basis, but with the

ECB, BOJ, and PBoC moving in the opposite direction to the

Fed by easing monetary policy, very little stands in the way

of further USD strength. SEB believes that the Fed will hike

in September this year, and that it will continue to hike in

small steps throughout 2016 in order to avoid excessive

USD strength, and not to choke the recovery. Nevertheless,

market uncertainty will likely continue to boost US assets

relative to EM before the event. However, once the Fed’s

plans are clearer and inflation expectations rise again, EM

rates will go up at a faster rate than in the US, attracting

new capital inflows. The decision to hike will be more or less

fully anticipated by markets, which should boost risk

appetite and EM assets, much as it did at the start of the

last rate hiking cycle in the US between June 2004 and June 2006.

The chart above plots a nominal EM FX index consisting of

BRL, IDR, INR, TRY, and ZAR (equally weighted) against a

basket of 50% USD, 25% EUR, 12.5% GBP, and 12.5% CHF.

The currencies weakened sharply against the basket in the

run up to the initial hike, but strengthened by more than

16% during the first 18 months of the cycle. The key factors

behind the strengthening were investor certainty that the

FOMC would tighten monetary policy at a measured pace,

an improving global growth outlook, and the initiation of a

global commodity boom. Now, the first two of those three

factors look likely to fall into place. While another surge in

commodity prices is unlikely, rising global growth will put a floor under the declines that have occurred since June 2011.

A key risk to the outlook is lower than expected inflation in

emerging markets. At the outset of 2014, we thought that

the most likely surprise towards the end of 2014 could be

higher inflation. However, it turned out to be lower inflation,

due to persistent slack in productive capacity, and lower

energy prices. For 2015, history is unlikely to repeat itself,

and inflation in EM should be boosted by weak currencies,

reduced slack, and gradually increasing energy prices. In

other words, the global monetary easing cycle (save for a

couple of exceptions) will come to an end early in the third

quarter. Rising rate expectations will widen spreads against

the US and, especially Japan and the EU, which will lift EM returns.

EM OUTLOOK: FX, BONDS, AND EQUITIES

All EM currencies that we track have weakened against the

USD over the past year, except PHP, which is largely flat.

Many EM currencies now look very cheap. The worst

performers have been in CEE and Latin America, and the

best in Asia, with the CNY, THB, and INR depreciating only

marginally. However, although, the CEE currencies

(together with the EUR) currently look particularly

undervalued against the USD, they are unlikely to stage a

sharp recovery over the 6-month forecast period, due to

EUR weakness. We expect EUR to weaken to 1.02 against

USD by the end of the year, and although the CEE will likely strengthen against EUR, they will weaken against USD.

The Latin American (except MXN) and South African

currencies will also remain under pressure during the first

half of this year on a weak outlook for commodity prices.

However, the current pace of USD appreciation and EM

depreciation is not sustainable, and we expect currencies

such as the CLP, COP, and PEN to retrace at least some of

the losses suffered over the last year on the back of a

stabilisation of commodity and oil prices. For MXN, the price

of oil is particularly important, as a recovery will boost

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investor sentiment in the important energy sector and ease concern over public finances in 2016.

In contrast to the weakness and stagnation against USD

expected in the CEE and most of Latin America over the

next 3–6 months, most of the Asian currencies that we

track (except THB and TWD) look set to remain largely

stable, or even strengthen slightly against the USD after a short period of weakness in the second quarter of the year.

After falling sharply in January, most EM benchmark

government yields are now back to where they were, or

higher than in December. The exceptions are Russia,

Romania, China, India, Colombia, and Czech. The roller

coaster ride is the result of stronger-than-expected data

from the US, which has caused capital to flow back to safe

haven currencies such as USD, JPY, and GBP. Nevertheless,

despite the uptick, yields in CEE, Turkey, and South Africa,

as well as in most of Latin America will remain near record

lows over the next 1–3 months, due to low inflation

expectations, and still-low global interest rates. They will

fluctuate at historically elevated levels in Brazil and Russia.

They will continue to trend down in South Africa, China, and

India, due to moderating inflation expectations, monetary

policy easing, and growth concerns. Bouts of risk aversion

will provide a floor under rates. Rates will rise in 3Q'15 as

the Fed moves closer to hiking and the growth outlook

improves. Renewed tensions between Russia and the West may also put upward pressure on EM rates.

We don't make forecasts for EM equities, and limit our

comments to pointing out that EM equities have continued

to underperform relative to those in more developed

markets. As with general EM FX indexes, they now look very

cheap and may now perform relatively better compared to

QE infused stock markets in more mature economies,

especially in the US. Similarly to the FX markets, Asian

equities will likely fare better than their Latin American and Emerging European counterparts.

RISKS TO OUR OUTLOOK

Some risks to our outlook have been mentioned in the text

above, but a few additional political and economic risks

could also upend prospects for a gradual recovery in EM assets in the second half of the year.

China has the financial resources to manage a property

market correction. However, given questions about the

reliability of government statistics, risks of a crash cannot

be completely dismissed. Also, the choices that China will

make over the next year or two in terms of interest rate

liberalisation and with whom it chooses to cooperate will be

pivotal. Recent overtures with Russia are probably largely

symbolic, as Russia and most of the other countries that are

hostile to the West and, in particular, the US will not do

much to lift China’s wealth and standing among nations.

Nevertheless, tensions between China and the US, as well as Japan, are not far below the surface.

Excluding the oil and gas sector, Russia is too small as a

trading partner to have a major impact — positive or

negative — on the global economy. However, if the conflict

in eastern Ukraine were to escalate further and Russia

intervene militarily more openly, relations with the US and

EU could start down a slippery slope of tit-for-tat sanctions.

We believe that the conflict in eastern Ukraine will freeze

largely along the current lines. Kiev cannot afford to

continue the war, while Russia does not need the rebels to

take additional territory to prevent Ukraine from joining

Nato. Nevertheless, rational choices do not always prevail when national sentiment is stirred.

In addition, although it may lie further into the future than

our 6-month forecast horizon, risks of a disorderly

unwinding of central bank QE programmes on a global basis

should not be ignored. We are in uncharted territory QE

with yields at historically low levels in what used to be high-

risk countries. The potential latent volatility could be

substantial, if we see a sudden re-pricing of risk globally, something of which in particular the BIS has warned.

Last, but not least, country-specific risks loom as large as

ever. Brazil is in the midst of the largest corruption scandal

in modern history, crimping investment and curtailing the

government’s ability to consolidate public finances. But the

woes for Brazil does not end with potential rating

downgrades, as it also faces the worst drought in 80 years.

Turkey’s political environment is deteriorating with

President Erdogan openly pressuring the central bank to

ease monetary policy. Additionally, the fight against the

Gulenists also risks undermining Turkey’s administrative

(government) institutions, jeopardising long-term governability.

Along with rising expectations on India has come the

potential for disappointment. With improvements in the

management of the Reserve Bank of India and strong

support in parliament behind the new reform-minded BJP

government, investor enthusiasm is well placed. However,

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India is a large and motley democracy and potentially only a terrorist attack away from a new war with Pakistan.

In addition, the technical picture points to significant challenges ahead.

TECH CORNER

The dollar bull market is the clearest when looking at it

through emerging markets lenses. Historically we know that

when the dollar enters a major bull trend (like in the mid-

1990s and the late 1970s) the result will be an emerging

market crisis somewhere around the globe. The first victim this time has been Russia, with Brazil as the runner up.

The impulsive rally in the dollar index has not only broken

above the “neckline” (in a similar fashion to the 1996 and

1981 upside breaks) confirming the major bull market that

begun 2008 and has broken above the falling top line from

1985 (and the Plaza accord) indicating that this rally

actually might be more powerful than the 1992–2001 one.

Such an outcome would put severe pressure on emerging market currencies for the foreseeable future.

Historically there’s also a strong correlation between a

rising dollar and underperforming emerging market

equities. As can be seen in the chart above the major dollar

index break higher 1996 led to the exit from a multiyear top

formation in the MSCI EM/DM relative performance graph.

With the recent major break higher in the dollar index the

risk for emerging market equities to underperform its major peers is marked.

The emerging markets bond index is still, like last year, in

the process of ending the right hand shoulder of a long-

term, head-and-shoulder top formation. The recent minor

bounce (from the December low point) looks corrective and

we thus see an increasing downside risk. A break below

105.50 (weekly close) would be the confirmation point for

the next sell off, which primarily will be targeting the 98-area (and secondarily the 88-area).

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SEB EM FX Forecasts (end of period)

12-Mar-2015 Spot 1M 2Q-15 3Q-15 4Q-15 1Q-16

vs. EUR

PLN 4.12 4.20 4.20 4.15 4.07 4.05

HUF 303 311 311 309 302 300

CZK 27.3 27.5 27.5 27.5 27.5 27.5

RON 4.43 4.50 4.50 4.45 4.39 4.30

TRY 2.75 2.84 2.84 2.85 2.86 2.85

RUB 64.5 69.6 70.4 61.8 56.1 53.0

RUB BASKET 62.5 67.0 68.5 60.8 55.5 53.0

vs. USD

RUB 60.9 65.0 67.0 60.0 55.0 53.0

TRY 2.59 2.65 2.70 2.77 2.80 2.85

PLN 3.89 3.93 4.00 4.03 3.99 4.05

HUF 286 291 296 300 296 300

CZK 25.7 25.7 26.2 26.7 27.0 27.5

UAH 21.75 30.00 30.00 30.00 30.00 30.00

ZAR 12.19 11.70 11.95 12.20 12.50 12.70

KES 91.7 92.0 92.0 93.0 94.0 95.0

NGN 200 200 200 200 200 200

BRL 3.13 3.13 3.20 3.30 3.40 3.45

MXN 15.46 15.00 14.70 14.40 14.10 14.00

CLP 638 620 650 660 670 670

CNY 6.26 6.35 6.25 6.20 6.25

CNH 6.28 6.35 6.25 6.20 6.25

HKD 7.77 7.80 7.80 7.80 7.80

IDR 13,183 13,500 13,000 12,800 12,800

INR 62.6 64.0 63.0 60.0 60.0

KRW 1,126 1,140 1,130 1,110 1,110

MYR 3.69 3.73 3.70 3.65 3.67

PHP 44.2 45.5 44.0 43.0 43.0

SGD 1.38 1.40 1.38 1.37 1.38

THB 32.8 35.0 34.5 34.0 34.0

TWD 31.6 32.7 32.5 32.3 32.5

EUR/USD 1.06 1.07 1.03 1.02 1.00 1.00

USD/JPY 121.2 121 125 128 130 135

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Theme: China — Focus on the Currency, Not Interest Rates

Market’s attention has been on China’s monetary easing

where the central bank (PBoC) has delivered 2 interest rate

cuts after 2 years on hold. Most China analysts including

SEB expect more to follow. Monetary easing has been an ongoing trend for the last 12 months.

Instead of interest rates, investors should focus on the

recent change in foreign exchange policy. We are starting to

see the central bank’s behaviour shifting to allow USD/CNY

fixing to rise (i.e., weaken CNY vs USD). In addition to

shorting CNY vs USD, we think the best way to invest would

be to continue to be short commodities and the Australian

Dollar (AUD), or in Asia to be short the Malaysian Ringgit (MYR) or Singapore Dollar (SGD).

WHAT’S HAPPENING TO INTEREST RATES?

Effective March 1, the PBoC reduced the 1 year deposit and

lending rate by 25bps to 2.50% and 5.35% respectively

(see chart below). This adjustment is very similar to the one

on November 22 where in addition to easing, the maximum

deposit rate flexibility was increased to 1.3 times the official

deposit rate from 1.2 times. PBoC stated that it eased to

reduce real rates since inflation is falling, to spur lending

and to continue structural reform in interest rate liberalization.

Similar to the November adjustment, we don’t see the cut in

deposit rate to be much of a stimulus. After the last cut,

most major banks raised deposit rates to 3.3% (the deposit

rate of 2.75% times 1.2), higher than the benchmark rate of

3% before the rate cut. The maximum deposit rate will be

3.25% (2.50% times 1.3) so banks will only reduce deposit

rate by 5bps to prevent deposits from moving to

competitors. The one difference this time was that the cuts

in deposit and lending rate are the same amount, whereas

in November the lending rate was cut by a bigger 40bps.

The asymmetric cut last time put more pressure on bank’s

margins but this time the margin pressure will not be as large.

Going forward, we expect 2 more cuts over the next 2

quarters as we expect the economy to ease further and

inflation to remain tame (chart below). For markets, equities

will rise from the slightly-earlier-than-expected easing. Buy

Chinese equities is one our top investment themes for 2015 and it will continue to benefit from further easing.

MORE IMPORTANT DEVELOPMENT IS THE BEHAVIOUR CHANGE IN FOREIGN EXCHANGE POLICY

Media and market attention has been on interest rates, but

we think the bigger policy shift is happening in foreign

exchange (CNY). CNY has been weakening recently but it

has been limited by the daily fixing by PBoC and the +/-2%

daily trading band. USD/CNY is trading close to the top of

the band and any further rise was limited unless PBoC’s

policy shifted to allow for weaker CNY. We think that moment has come.

The chart below shows the difference between our daily

USD/CNY fixing forecast versus the set PBoC fixing at

9:15am Beijing time. We use this to track whether PBoC is

shifting exchange rate policy. In normal markets like 2013,

the chart oscillates up and down, like a heart rate. It shows

that central bank is letting market movements dictate the

fixing and our forecast misses randomly up and down.

However, in early 2014 the fixing was consistently set

higher than our forecast and showed a deliberate policy

shift to take USD/CNY higher. Then in May 2014, the policy

shifted back to normal where we again missed equally on

both sides and with a small shift lower, showing a bias to

take USD/CNY lower. But as you can see, starting February

this year, we are seeing fixing higher, which signals another

policy shift to take USD/CNY higher. If PBoC wants to weaken CNY, it’s best to get out of the way and join them.

11


USDCNY Model-to-Fixing Difference

Source: Bloomberg, SEB calculations

Two Scenarios

The reason and intention behind a weaker CNY will have

different consequences. Differentiation needs to be made on whether a weaker CNY is a “cause” or “effect”.

THE MOST LIKELY SCENARIO — “EFFECT”

The most likely reason why authorities are allowing for

weaker CNY is an “effect” from weaker relative

fundamentals. China’s growth is slowing and long term

expectations for China’s growth are also shifting lower to

what authorities call a “New Normal”. On the other hand,

the US economy is accelerating and trend growth appears

to be returning to historical norms. Capital becomes

attracted to the more profitable US economy relative to

China and that flow reversal weakens CNY. In addition,

Chinese households and corporates are adjusting to two-way CNY volatility and hedging by selling CNY.

Capital outflows have occurred before even though China

technically has a regulated capital account. The chart below

shows the capital outflow derived from the balance of

payments data and it includes “errors and omissions”,

which catches masked capital flows. We had capital outflow

during the 2008 Lehman crisis, in 2012, and starting in Q2 2014.

THE DISASTER SCENARIO — “CAUSE”

The alternative, negative scenario is when CNY weakness is

a “cause” where the authorities are devaluing the currency

to gain exports market share and increase growth at the

expense of the rest of the world. This would fit the scenario

of China joining the global currency war. Currency wars

typically have 3 stages. First, countries manipulate foreign

exchange levels through direct intervention, or indirectly

using interest rates. Second, countries set capital controls

to manipulate and protect their currencies. Third and the

most potent stage is when countries attempt to directly

change the volume of trade with sanctions and tariffs. If

China devalues to gain export market share, we will

accelerate to stage 3 and the US and Europe will likely react

with trade restrictions. This will be negative for the global

economy and especially for China that ranks #1 in market

share in global merchandise trade and most dependent on

free flow of global trade. Since this scenario would be

similar to shooting yourself in the foot, we think CNY weakness is an “effect” more than a “cause”.

HOW TO PLAY IT?

The most logical way to hedge in a weaker CNY is to sell

CNY versus USD. However, the move will not be limited to

just CNY. In the chart below, we have analysed the

sensitivity of how other currencies and assets reacted in the

last 3 scenarios of CNY weakness (2008 Jun–Dec; 2012

Feb–Sep; 2014 Feb–Sep) and taken the average, lastly

ranking them in ascending order. The figures show the

sensitivity in percentage to moves in USDCNY. The most

vulnerable assets are commodity related, with gold being

number one, followed by oil and the Australian Dollar

(AUD). So a 10% move higher in USD/CNY leads to 15%

loss in the value of gold and 12% loss in AUD. IDR and MYR

are the most vulnerable of the Asian currencies, followed by

SGD. We prefer to be short SGD or MYR because the cost of

carry is low and SGD has lagged the general currency weakness move in Asia so far.

Sensitivity to USDCNY

Source: Bloomberg

The only one resilient to CNY weakness is the Japanese Yen

(JPY) where it will strengthen by 0.4 times the loss in CNY.

JPY still remains the safe haven currency. What we found

-60

-50

-40

-30

-20

-10

0

10

20

30

Dec

-13

Jan

-14

Feb

-14

Mar

-14

Ap

r-14

May

-14

Jun

-14

Jul-1

4

Au

g-14

Se

p-14

Oct

-14

Nov

-14

Dec

-14

Jan

-15

Feb

-15

Model to fixing difference in pips, 5 day mv avg

normal policy shift

normal

-0.4

0.10.2 0.3 0.3

0.4 0.5 0.6 0.6 0.6 0.7 0.7 0.7

1.0 1.0 1.01.2

1.31.5

-0.5

0.0

0.5

1.0

1.5

2.0

JP

Y

BR

L

CH

F

KR

W

MX

N

TH

B

TW

D

PH

P

RU

B

EU

R

INR

TR

Y

SG

D

ZA

R

MY

R

IDR

AU

D

OIL

GO

LD

Sensitivity to USDCNY

12


interesting was the resilience in Korean Won (KRW) but that

may be since KRW weakness recently have been driven by a weaker JPY and JPY strength may lead to KRW strength.

ONE CAVEAT

We are considering the current CNY weakness to be an

“effect” of weaker relative fundamentals and in this

scenario, developments in China’s biggest trading partner,

the EU, plays a significant part. One additional reason why

USD/CNY fixing will rise further is because the EUR/USD is

weakening. USD/CNY fixing is starting to reflect market

foreign exchange rate movements across China’s key

trading partners and not just focusing on the level versus

the USD. President Xi has pledged to have market forces

play a bigger role in resource allocation in his first major

policy announcement in November 2013 Third Plenary

Meeting. CNY policy is moving with the overall policy

direction in allowing markets to dictate the level. What this

means is that we expect CNY to weaken because we are

expecting the euro to weaken towards 1.05. If we are wrong

and euro starts to strengthen, we think CNY depreciation

also stops. This is different if we view the current CNY

weakness to be a “cause” where in that scenario, CNY will

weaken regardless of where EUR is headed. In addition, if

China is weakening the currency irrespective of changes in

other foreign exchange rates, we think all bets would be off

and it will be best to buy the safest assets such as gold and US Treasuries.

NOT FINISHED HERE — SECONDARY IMPACTS

In our main scenario that CNY weakness is the “effect” of

weaker economy, there would be other monetary consequences.

First, we’ll see accelerated monetary easing, which we are

already starting to see. The currency policy directly impacts

domestic liquidity conditions. As the chart below shows, FX

reserves on average are still growing, especially when

adjusted for valuation changes due to the weaker EUR-denominated reserves PBoC holds (green line).

China FX Reserves

Source: Bloomberg

The currency is still technically undervalued where in order

to prevent the currency from appreciating, the central bank

has to print extra CNY and buy USD or other assets. That

printing causes domestic liquidity to increase (represented

in the chart below by the light green area) and add to the

growth in the monetary base. In 2009 and 2010, in order to

limit domestic liquidity due to the large inflows, the central

bank had to remove liquidity by sterilization (sell bonds,

hence the red line is negative and subtracting from total

base money growth). Also, reserve requirement ratios were hiked as another form of tightening liquidity.

Contributions to Base Money Growth

Source: CEIC

Going forward, with less net inflow from capital outflow, the

central bank will have to add more liquidity to keep base

money growing at the same pace. This has already been

happening from 2012-2014 with addition of liquidity by

PBoC. The central bank will have to do more going forward

by cutting reserve requirement ratios further and open market operations that will drive interest rates even lower.

The second consequence is the impact of China

accumulating less FX reserves or even depleting its

reserves. That means China will be buying less US

Treasuries and Euro denominated assets. This combined

with adjustment in US monetary policy outlook will raise

term premiums in US Treasury market. The rise in US bond

market uncertainty will likely trickle through to higher volatility in most major asset classes.

ADJUSTING POSITIONING BY GOING LONG USD VS AUD, MYR, SGD

Due to the change in China’s FX policy, we will close our

short USD/CNH option and add a basket of short AUD, MYR

and SGD vs USD in allocate 100% weight in our Asia FX Portfolio.

-150

-100

-50

0

50

100

150

2000

2500

3000

3500

4000

4500

10 11 12 13 14 15

MoM change (RHS)

Total (LHS)

MoM valuation adj (RHS)

China FX reserves (USD mn)

-20

-10

0

10

20

30

40

09 10 11 12 13 14 15

% yoy 3mma, contribution to base money growth

FX res contribution

Sterilization contribution

Base money adjusted for RR

13


Theme: Effects of Lower Oil Prices

Since July 2014, oil prices have fallen by some 50% from

USD 110-115 per barrel to current levels around USD 60.

The price fall has been driven by a combination of factors.

Increasing supply is one explanation. Production has

increased, especially in the US due to the shale oil industry,

but also in Brazil and Canada. At the same time, demand

growth in China and Europe has moderated and contributed

to the downturn. The OPEC countries have not sacrificed

their market shares in order to prop up oil prices resulting in

growing oil stockpiles that push down prices. SEB predicts

an average Brent crude price of USD 60 in 2015 and USD 70 in 2016. In November 2014, the forecast was USD 85/barrel.

Oil price downturns are usually positive for the world

economy and global GDP growth. However, country-

specific effects vary widely. The big winners will be

economies that are heavy users of energy and dependent

on oil imports. Taking a look at the BRIC economies and

Turkey reveals that there are two clear winners (India and

Turkey), one obvious loser (Russia) and two economies where effects will be limited.

GLOBAL EFFECTS: GROWTH STIMULUS AND LOWER INFLATION

An oil price downturn leads to a transfer of resources from

oil exporting to oil importing countries. Since the inclination

to consume is normally higher in the latter, oil price

downturns are usually positive for the world economy. The

most important channels are stronger household

purchasing power, lower costs for input goods and monetary policy easing due to lower inflation.

However, there is reason to be cautious regarding the

positive growth impact of cheaper oil this time around. Due

to higher post-crisis indebtedness, consumers in importing

countries may use their increased room for consumption to

pay off debt and increase savings instead. Also, the net

effect on US growth will be smaller than before due to the

considerable expansion of the country’s oil industry. SEB

expects that a 50% decrease in oil prices results in a global GDP stimulus of 0.75% over a two-year period.

COUNTRY-SPECIFIC EFFECTS ON EM ECONOMIES

India: Clear Benefits

India is one of the main beneficiaries of lower oil prices due

to large energy imports and dependence on agriculture.

Energy is the main input into fertilisers. Subsidies on fuel,

fertilisers and food have been one of the main factors

behind India’s substantial budget deficit. The decline in

energy prices contributed to the government’s decision in

October 2014 to deregulate diesel prices and raise domestic

natural gas prices. This implies that the positive growth

effect of increased household consumption instead

materialises in the form of reduced government

expenditure for energy subsidies. However, as presented in

the budget published recently, government will be able to

increase spending on infrastructure providing a positive growth effect.

The fall in energy prices and food prices have been the main

drivers of the sharp decline in CPI inflation, as well as

inflation expectations. The Reserve Bank of India (RBI) has

already cut its key interest rate arguing that slower inflation

provides room for a shift in the monetary policy stance. More cuts are expected, which will boost GDP growth.

Russia: Deep Recession in 2015

Russia is highly dependent on energy exports. Oil

represents about 60% of total exports and more than half

of government revenue. The failure to diversify away from

energy exports is one of the main factors that are driving

Russia into a deep recession in 2015. The rouble is highly

correlated with oil prices and the recent downturn has pushed the rouble to record lows.

14


The weaker rouble will have a big impact on the economy.

Inflation has accelerated to close to 17% year on year,

driven by rising import prices. It will deal households a

powerful blow through a sharp weakening of real wages.

The financial turmoil and currency weakening has forced

the central bank to hike the key interest rate to 15%

currently. High interest rates will trigger a further downturn

in capital spending that has been weak for a long time due

to underlying structural problems. The lower oil price also

rules out expansionary fiscal policy and creates pressure on

the balance of payments. All in all, the fall in oil prices will

result in a broad and deep fall in GDP in 2015. SEB expects GDP to decrease 5.5 per cent.

China: Limited Benefits Despite Large Oil Imports

As the world’s second largest net importer of oil in absolute

terms, China is benefitting from lower oil prices, primarily

through a strengthening of the trade balance. However,

heavy reliance on coal means that the share of oil in total

energy consumption is relatively small at 18 per cent.

Therefore, the main channel for exposure is the transport

sector and CPI inflation is not very sensitive to oil price

changes. Price controls further reduce the impact of lower

prices on inflation. The growth impact of the lower oil price

is small, but there are some other benefits. Similarly to

India, cheaper oil will support the government’s efforts to

reduce energy subsidies. Efforts to deal with environmental

problems will also be simplified, for example by making it easier to phase out dirty vehicle fuels.

Turkey: Smaller Twin Deficits

Turkey relies heavily on foreign fuel. Net imports of oil

products represent more than 6% of GDP. The main benefit

of the oil price drop will be a reduction in the import bill and

in the current account deficit. The budget deficit will also be

reduced since a smaller energy import bill implies less

public spending on transfers to state owned energy

companies. Lower petrol price inflation will also provide a

boost to household real income. The fall in oil prices has

improved the growth outlook, but there are several

remaining vulnerabilities in the form of high dependence on

foreign financing and an unsustainable surge in private sector credit.

Brazil: Mixed Effects

The effect on Brazil will be mixed. Crude oil exports are

increasing, but Brazil is still a net importer of oil products.

Lower oil prices make it more difficult to attract investment

to develop the vast offshore oil reserves. Fuel prices are

subsidised by state owned oil firm Petrobras; oil is imported

at world prices and sold at a capped rate. Therefore, the

effect on household consumption is expected to be small.

On the other hand, there are also short-term gains of lower

oil prices. Petrobras can spend less on subsidies, creating more resources to spend on production.

15


Strategy: Based on Medium-term EM Strength

Trading Recommendations

GO LONG USD VS AUSTRALIA (AUD), CHINA (CNY), MALAYSIA (MYR), SINGAPORE (SGD), AND THAILAND (THB)

Monetary policy is being eased in key Asian economies. In

addition to shorting CNY vs USD, we think the best way to

invest would be to continue to be short commodities and

the Australian dollar (AUD), or in Asia to be short the

Malaysian ringgit (MYR), Singapore dollar (SGD), or Thai baht (THB).

LOOK TO SELL USD/MXN

Mexico will forge ahead with reforms in the energy sector by

making contract terms attractive enough for investors

despite the fall in oil prices. Mexico stands to be one of the

first beneficiaries of the pick-up in the US economy, when investors have more clarity on the pace of US rate hikes.

LOOK TO SELL USD/RUB

We do not believe that Russia will openly intervene militarily

in Ukraine, as a frozen conflict is enough to prevent Ukraine

from joining NATO and to make integration with the EU very

expensive (for the EU). The ruble currently looks

undervalued and will benefit from a gradual recovery in the price of oil.

LOOK TO SELL EUR/PLN, HUF, RON

Emerging Europe, especially Poland and the Czech, is a

convergence story about to happen. We believe that once

the EU starts a sustainable recovery, even if slow, the CEE 4

currencies will resume their gradual appreciation against

the EUR. In the short term, the trade would also protect

against a potential temporary rebound of the EUR against the USD.

Fixed Income: Diverging Dynamics

The first half of the year is likely to be characterized by

divergence, as developed markets (most importantly the US

and the EU) start to growth faster before pulling along the

EM economies. How are policy makers in emerging markets

going to react to recent shocks in the form of a drop in oil

prices, and rising global deflationary trends? Some

countries, especially in the CEE area, have followed other

central banks’ lead in an orderly fashion, such as Poland,

Romania and Hungary, by clearly communicating their

strategy and cutting rates. However, others have been more

opportunistic and seized the opportunity to cut rates in the

view of a temporary relief in inflationary pressures (e.g.,

China and Indonesia). There are also countries with a

structurally high underlying inflation, such as Turkey, that

may well regret current easing steps down the line, as

higher US rates raise market stress and oil prices increase

from current levels. When the dust settles, we should see a

gradual improvement in EM growth, as the effects of

stimulatory monetary policies kick in and political uncertainties, such as Ukraine/Russia crisis, subside.

High hopes have been placed on lower oil prices to give

some EM countries a much-needed fillip. And also they

raised concerns for oil exporters, how those are going to

weather this downturn. Effects of lower oil prices are not

straight forward. Whilst some EM countries are crude oil

exporters, many of them also import refined products. And

lower energy prices might not benefit the end consumer, as

often energy prices in these countries are subsidized and

governments seize the opportunity to remove these

subsidies. Hence, consumers may not get the full benefit of

lower prices, which, in turn, may lead to only a small impact on inflation.

EM BONDS: WHERE DO WE STAND?

For now, the general topic in the EM bond space remains

focused on much similar things as in our previous

publication. All eyes are on the US rate move and world-

wide inflation. Although, it can be argued that there is more

room now for rate cuts in most CEE countries, the process is

surprisingly complex, with many nuances that need to be

considered. We expect most CEE central banks to follow the

ECB’s path of monetary easing in some form, but there is

not much certainty of action. It has been mentioned that

the deflationary pressure is often imported into the region and not the CEE countries’ “fault”.

Looking closer at EM bonds, the fixed income benchmark,

the GBI EM Global diversified, spread to UST is 485 bps,

which is slightly below the average value, but that could be attributed to the recent move in UST.

It is hard to see any real buying opportunities in Ukraine at

this stage. But Russian asset prices are mainly driven by oil,

16


which can be perceived as a positive thing to a certain

extent. It would seem to indicate that investors have shifted

their focus away from the geopolitical noise. The future

path of oil prices is still very uncertain, but for now, it seems to have reached a bottom.

EM BONDS: CHALLENGES AHEAD

Developments in the EM sovereign credit space are likely to be affected by three factors in the near-term:

1. Monetary tightening in the US;

2. ECB’s quantitative easing program. It already had a

strong impact on EUR denominated bonds from the

CEE countries that are eligible under this program.

Yields have contracted between 10 and 30 bps since

the announcement of the buying program; and

3. Decline in oil and commodity prices. These may have

a long-lasting impact on external balances of EM

countries.

Obvious risks weighing on that space are debt restructuring

in Ukraine, a deepening recession in Russia and a likely

default in Venezuela. The outlook for EM FX remains

negative until the Fed hikes. Although, as history shows, it

tends to stabilize following the Fed move. In fact, USD may

peak at the time of the first rate hike. There are also

challenges facing EM corporate credit that may weigh on

the sentiment of an entire country’s debt, as the recent

cases of Petrobras in Brazil and Kaisa in China illustrate. To

make matters worse, policy credibility has recently come

into question across the region, be it in Russia, Turkey, or Venezuela.

Many of these risks are likely to be mitigated by strong

underlying inflows into EM funds. A large number of bond

repayments and coupon payments are also going to be an additional source of substantial amounts of liquidity.

Looking at hard-currency debt, it is difficult to say whether

it is poised to outperform local currency debt or not in the

months to come. One thing that we are fairly certain of is

that EUR-denominated bonds are likely to gain a greater

importance due to their ECB purchasing program eligibility.

A large portion of new issues out of CEE is likely to be in

EUR. Perhaps, as much as 30-50% of EM sovereign new

issuance this year might be denominated in EUR. We have

already started seeing that, with Croatia and Mexico placing EUR-denominated bonds.

There would seem to be very little juice left in local CEE

rates. And those are also sensitive to moves in UST rates,

due to their investor base, i.e., US accounts chasing higher

yields. In general, local currency spreads to UST are either

record tight or close to it. Historically, this can be taken as an indicator that USD bonds should outperform.

But, having said the above, spreads to DM government

bonds for hard currency EM bonds, especially in low-beta

names, are quite tight as well, leaving those exposed to

external shocks. These tight valuations are unappealing and

warrant some caution. Higher quality EM credits can be

used for capital preservation in times of heightened global

uncertainties and volatility, but one should not expect any stellar performance from these bonds.

In Latin America, Brazil’s valuations appear attractive. But

renewed downgrade risk amid deterioration in the growth

outlook, political risk, and Petrobras’ scandal will continue to exert pressure on Brazilian assets in the near term.

SEB EM BOND BASKET UPDATE

Since our last EM Explorer cut off in October 2014, our

portfolio has delivered a return of 0% in local currency and

-16.6% in USD terms. During the same period, GBI EM returned 0.63% in local currency and -12.3% in USD terms.

At the time of writing our last Explorer, we were hoping for a

positive resolution of the situation in Ukraine in the near

future. That proved to be wrong, the situation around

Eastern Ukraine is still far from being resolved and, if

anything, it has become more entangled. The Minsk-2 truce

agreement is fragile and implementation risk is high. Falling oil prices intensified the fall in RUB and bond prices.

All currencies in our portfolio had a negative development

over the past six months, with Russia and Brazil, where we

had our largest overweight positions, standing out. Russia

and Brazil bonds added the most stress on the yields’ side

to our portfolio, as well. Following S&P and Moody’s

downgrades of Russia’s sovereign ratings to junk, Brazil and

South Africa may be next, risks that are currently in the process of being priced in.

RE-SHUFFLING OUR PORTFOLIO

We are increasing the weight in Hungary, given a potential

upgrade of the country’s rating. We are pulling Turkey to

market weight, after the political turmoil surrounding the

central bank. We are going underweight in South Africa, due

to a potential downgrade. And, finally, in Poland, we are

going slightly underweight, after the central bank signalled

SEB Bond Portfolio Oct 8 2014 to Mar 10 2015GBI-EM weight

SEB weight Yield

Duration years

08 October 2014 `ìêêÉåÅó= içÅ~ä=êÉíK rpa=êÉíK

Poland 10% 10.0% A- 2.30% 4.4 JNQKVB NKSB JNPKRBHungary 5% 3.0% BB 2.67% 2.8 JNRKSB PKNB JNOKVBS. Africa 10% 10.0% BBB- 7.45% 3.6 JVKOB QKMB JRKSBTurkey 8% 12.0% BB+ 9.41% 3.0 JNPKPB SKMB JUKMBS. Korea 0% 5.0% A+ 2.26% 1.9 JQKPB NKRB JOKVBRussia 9% 15% BB+ 9.71% 6.4 JPRKTB JNRKNB JQRKQBIndonesia 7% 5.0% BB+ 7.90% 2.3 JSKRB RKNB JNKTBMalaysia 10% 10.0% A- 3.10% 3.2 JNNKTB MKMB JNNKSBBrazil 10% 15.0% BBB- 11.91% 2.0 JOPKPB OKPB JONKSBMexico 10% 15.0% BBB+ 4.45% 2.8 JNPKQB NKNB JNOKRB

Average 100.0% BBB 6.9% 3.5 JNTKNB MKMB JNSKSBGBI-EM: 0.63% -12.3%

mÉêÑçêã~åÅÉ=ëáåÅÉ=çÅí=U

Rating S&P

(LT-FC)

17


that the rate cutting cycle may be over. The bonds were looking rather expensive, even pre-announcement.

However, we are keeping our overweight positions in

Russia, Brazil and Mexico. We still believe that EM FX is

currently looking very cheap and it is likely to perform well post the initial US rate hike.

The new portfolio composition can be seen below.

New SEB EM Bond Basket Mar 10 2015GBI-EM weight

SEB weight Yield

Duration years

10 March 2015

Poland 10% 10% A- 2.15% 4.2Hungary 5% 5% BB 1.87% 2.5S. Africa 10% 8% BBB- 7.19% 3.3Turkey 10% 10% BB+ 8.63% 2.7S. Korea 0% 4% A+ 1.92% 1.5Russia 4% 15% BB+ 13.34% 6.0Indonesia 9% 8% BB+ 6.98% 1.9Malaysia 10% 10% A- 3.55% 2.9Brazil 10% 15% BBB- 13.63% 1.7Mexico 10% 15% BBB+ 4.75% 2.5

Average 100.0% BBB 7.5% 3.1

Rating S&P

(LT-FC)

18


Election Monitor

The following elections are due in Q2 and Q3 2015 in the EM markets that we cover. The table contains dates, our predicted winners and the pre- and post-impact of the elections on the countries’ currencies and economies.

Country Election/Date Predicted

Winner Currency

Impact Election Impact

Nigeria General

(March 28th)

The People’s

Democratic Party

(PDP)

Negative/

Neutral

The election has been postponed six weeks due to

security concerns related to Boko Haram. The ruling

People’s Democratic Party (PDP) is the likely winner,

but it is rapidly losing ground to the newly formed

All Progressives Congress (APC), leaving the

outcome highly uncertain. The APC has indicated

that they are more willing to fight corruption and

press ahead with structural reforms than the ruling

PDP. A key concern surrounding the election is

election fraud which may spark civil unrest.

Poland Presidential

(May 10th)

Civic Platform

(PO) Positive

Incumbent President Bronislaw Komorowski is likely

re-elected as President for the second time. He will

run as an individual but is supported by the ruling

Civic Platform (PO). He has managed to stay in the

middle of the road, avoiding controversies and

focusing on national defence and families. This has

made him very popular and he has currently over

60% support. The main opponent is Andrzej Duda

from Law and Justice (PiS) although polls show he

has only 17% of the votes. Polls show that also PiS

voters supports Komorowski.

Turkey General

(June 7th)

The Justice and

Development

Party (AK Party)

Negative

The incumbent President, Tayyip Erdogan, is

seeking a supermajority in parliament. He has made

no secret of wanting to amend the constitution to

increase the power of the presidency. Erdogan is the

founder of the AK party, which currently holds 313

of the 550 seats in parliament. He will try to boost

his popularity ahead of the election by providing

fiscal and monetary stimulus. It will result in a

widening of the current account and budget deficits

as well as accelerating inflation and further lira

weakness.

Poland Parliamentary

(October 26th)

Civic Platform

(PO) Positive

Civic Platform (PO) has been ruling for seven years

and will likely stay in power by forming a coalition

government with the Polish Peasants Party or the

Democratic Left Alliance. Economic growth and the

Ukraine conflict has helped PO’s popularity.

However, PM Ewa Kopacz is perceived as a weak

leader and she has not performed well in regional

elections. Poor communication skills and

controversial nominations weigh on her popularity,

but if she manages upcoming coal sector reforms

well, she will collect important points. Opposition

party Law and Justice (PiS) is popular in regional

elections, but would have to form a coalition with

right-wing Nowa Prawica, which will be a tall order.

19


Country Section

Asia

China

Economic growth will slow to 7.0% in 2015 compared to

7.4% in 2014. China’s economy runs on two main engines:

a) external demand through exports; and b) domestic

demand measured through construction activity. In 2014,

both engines stalled, but the outlook for exports in 2015

should improve on the back of US growth. Domestic

demand via construction is stabilizing from looser policy.

However, the recovery will be weak because the

government has switched from targeting quantity in

monetary stimulus (i.e. amount of loans banks need to

provide) to price (adjusting interest rates). The economy is

not as responsive to interest rate adjustments and the

government will have to do more monetary easing to

support the economy. We expect 50bps cut in deposit rates

and 150bps cut in reserve requirement ratio. Another part

of the economy suffering and the main drag on growth in

2015 is capital expenditure. With lower housing activity,

many steel and cement factories will not increase capacity and some will be even shut down.

CNY will oscillate this year and we expect it to finish around

6.20 by year end. Over the long run, the currency will

continue to appreciate since the current account remains in

surplus and politically, it is easier than depreciate the

currency and risk trade tensions with EU and US that can

reduce trade volumes by double digits. The change this

time is that we can no longer just sit on a long CNY vs USD

position because volatility has increased and the trade can

move 4% against you in one day. Over the short run, as

written above, we think USD/CNY will head higher towards

6.40 and prefer to be short CNY. On rates, we want to

receive since we expect more rate cuts. With lower inflation

and economic activity, they will have room to ease. This will

benefit equities and the substitution effect moving from

housing investment into the equity market will also be a key driver.

CNH TECH CORNER

The market is headed towards a medium-term target at a

6.37 "Equality point". As a slightly more ambitious objective,

the late 2012 high of 6.39 could also be used. Support is

hardening around the mid-2014 high of 6.27 and the

ascending 8-week "Tenkan-Sen" (a rolling 8-week, high-low

average), which comprises a medium-term “fair value”

around which the market oscillates. The Tenkan-Sen works

as a trend and level identifier, finding dynamic-support at 6.25 currently.

Hong Kong

The tension between Hong Kong and mainland China

persists even though the protests in Hong Kong faded and it

is unlikely to go away anytime soon. Discontent in Hong

Kong has been a multi-year trend and rooted in social and

economic inequality. The Chinese government appears to

make this conflict a war of attrition. The protests hurt the

Hong Kong economy and Beijing has a bigger pocket to

withstand the pain. On the other hand, we don’t expect a

mass violence since the situation in Hong Kong has not

deteriorated enough. Unemployment rate is still low and

GDP per capita is high that residents have much to lose if

the situation becomes violent. So we see a muddle through scenario and weigh on Hong Kong’s economic performance.

We don’t like HKD and look to use it as a hedge for USD

strength. USDHKD is trading at the very bottom of the peg

at 7.75 and cannot get any stronger from a more positive

macro environment. Hong Kong inherits US interest rate

policy from the USD peg and low rates have pushed up

asset prices in Hong Kong. However, there are several risks

for a weaker HKD. One, as the US economy recovers, US

yields rise from a hawkish Fed. The rise in rates through the

peg will pressure Hong Kong rates to rise and lower Hong

Kong asset prices. Both of these will make HKD weaker.

Furthermore, long USDHKD can act as hedge if China or

general global risk re-emerges. Long USDHKD is also a small positive carry hedge.

India

For 2015, Prime Minister Modi’s ascent to power will only

make a small difference to the economy and will recover

only to 5.8% compared to 5.3% in 2014. Instead of

focusing on reforms, the recovery will come from monetary

easing. January’s inflation at 5.1% has finally fallen within

RBI Governor Rajan’s target of 4% +/-2%. Some of this was

due to lower commodity prices and this will give room for

more easing. The RBI has delivered a 25bp rate cut in an

unscheduled meeting in mid-January. We see another

75bps of easing in 2015 to decrease the policy repo rate to

20


7.00%. This will give room for businesses to start the capex

cycle and for households to increase consumption. Over the

medium term, Mr. Modi is improving the growth outlook by

moving government spending away from subsidies (hand-

outs that win votes) to investment and this will improve the investment outlook.

The lower oil price and removal of fuel subsidies will

improve India’s trade balance. For 2015, we don’t see much

movement in INR but we would like to go long to pick up

carry of around 6% annualized once we get over the current

taper tantrum. We see USD/INR return to 60 by year end.

For rates, we prefer to receive the front end, since we

expect more rate cuts and economic growth to regain traction.

Indonesia

The economy will have a small recovery to 5.4% in 2015

from 5.1% in 2014. Indonesia can typically grow 6% or

higher but it is facing two headwinds. First, export recovery

is slow because thermal coal, natural gas and palm oil prices

are its main exports and their prices remain low. In addition,

the mineral export bans remain in place and hurt export

volumes. Second, credit demand is slowing and will

decrease domestic investment and consumption. The

central bank eased rates by 25bps to 7.5% in the last policy

meeting to support lending and inflation is falling post the

fuel price hikes. We think the central bank can ease another

25bps in Q2 to further support growth since inflation should

continue falling. The upside risk to growth we see is more

public investment as President Jokowi is encouraging more

infrastructure project but they will have more of an impact

in 2016 than 2015. The one risk we are seeing is political

infighting that can delay Jokowi’s attempt to reform.

Jokowi’s ability to centralize power appears to be taking

longer than expected and can hinder the high expectations markets hold for this popular President.

IDR is weakening from general USD strength, a current

account deficit that is slow to improve, and policy easing.

We think the last rate cut was premature and shows that

the central bank is more comfortable with a weakening IDR.

Also, FX policy appears to have changed where instead of

protecting levels, the central bank is letting IDR depreciate

gradually and limit large moves. With a stronger USD, we

could see continued weakness in IDR. On rates, we

recommend receiving since we see another cut and longer

end bond yields will likely drop because growth will be low

with inflation. With currency weakness, hard currency debt

is better than local currency. Equity market should do well from easing and low rates.

South Korea

The economy has been weak from lacklustre exports to US,

Europe and China. Domestic demand has also been weak

since the private sector debt is one of the highest in the

world. The high debt is the result of historical economic

policy of relying on credit to sustain high growth. With

everyone leveraged up, trend growth will likely fall as Korea

abandons the “borrow and grow” strategy. In addition,

Korea will likely have lower inflation. With less investment,

demand for funding will decrease and creates “excess”

savings, which will drive interest rates lower. One change

we see recently is from President Park. She is starting to

relax some populist measures against Chaebols where she

has learned that help from Chaebols are needed to get the

domestic economy going. The dead property market has

gained relief where major property projects are getting

approved faster than expected. The policy shift can reverse Korea’s underperformance.

Korean Won (KRW) has been weakening following the

Japanese Yen (JPY) despite the high current account

surplus. The likely causes of weakness are speculative

positions and foreign selling in the equity market. Short

term, we expected further KRW weakness because we

expect the central bank to ease rates 50bps to bring the

policy rate to 1.5% from 2.0%. BoK has stubbornly held

interest rates on hold due to rising household debt.

However, this was the same routine in early 2012 but later

embarked on cuts, following the rest of the world in easing.

We expect BoK to be pragmatic and repeat the same

pattern this time. Since we expect cuts, we still prefer

steepeners and not receive or hold bonds in short end rates

since the currency weakness can eat away the interest gains.

KRW TECH CORNER

The market likes it above the rolling 21week high-low

average (aka "Kijun-Sen"), which identifies dynamic support

at 1,088, followed by a prior 1,074 below. A 5-wave impulse

is unfolding, now developing its 5th

leg higher. This should

be followed by a 3-wave correction before another 5-leg

sequence is initiated. Overhead attraction/resistance are

found at primarily 1,168 and secondly at 1,189.

Malaysia

We expect Malaysia’s economy to slow to 5.2% in 2015

from 5.8% in 2014 from fiscal contraction. PM Najib gave

cash hand-outs in 2013 to influence the last election and he

21


will be reversing them in 2015, which will weigh on growth.

The measures are unfavourable to the public but positive

for long term economic growth. A 6% VAT tax will

commence in April 2015 and slow consumption. Similar to

Indonesia, exports will face headwinds since Malaysia is

reliant on palm oil and natural gas exports. The lower

commodity prices will also weigh on revenue projections

and slow public and private investment. In 1H 2015,

Malaysia will announced the 11th Five year plan and will

likely continue the path towards more private sector

involvement and increase in infrastructure spending,

especially in the energy sector (natural gas) over the long term.

MYR has suffered from rising US yields and lower

commodity prices. Foreigners own more than 40% of the

government bond market since Malaysia was stable and

offered higher yields relative to the US. However, possible

rise in US yields are leading to unwinding of these positions

and hurting MYR. Also, lower commodity prices are hurting

Malaysia’s the most in Asia because they have historically

had a large current account surplus to support MYR but that

is diminishing rapidly. We expect MYR to weaken in 1H but

we think most of the big moves have taken place already.

We expect interest rates to be on hold at 3.25% with a small

risk of easing to support the economy. We would be bias to receive front end rates.

Philippines

The economy should accelerate to 6.2% in 2015 compared

to 6.0% in 2014. Philippines faced economic headwinds

last year from typhoon Haiyan and policy tightening but we

expect a small rebound as the economy normalizes and

public investment will rise heading into the 2016

Presidential election. Furthermore, base effect from the

typhoon will push up growth and fiscal stimulus. President

Aquino’s term ends in mid-2016 and he will want the

economy to be strong going into it for the election as well

as for his legacy. Public spending has faced bottlenecks and

those will likely to be spent to prop-up the economy. The

recovery will not be strong as usual since monetary

contraction will weigh on growth. Interest rates had been

set at or below CPI for the last several years that has

propelled credit growth and domestic consumption. The

central bank maintained policy rates stable recently as

inflationary pressures eased but it may start hiking interest

rates again later this year in reaction to rising US rates and that will weight on consumption in 2015.

PHP has outperformed other Asian currencies since it has a

solid current account surplus and the central bank has

hiked rates in preparation for US hikes. However,

Philippines cannot fight the Fed and PHP will play catch-up

to rest of Asia especially in the 1H 2015 and peak at 46. On

rates, we prefer paying the long end since we expect more

fiscal spending to come through and the economy to

rebound in 2015. Policy rates will be on hold at 4% with risks of a hike towards end of 2015.

Singapore

The Singapore as a small, open economy will improve to

3.2% growth in 2015 compared to 2.9% last year on

improved export outlook. We don’t expect a huge rebound

since Singapore is following China in improving the

composition and quality of the growth. Singapore is limiting

immigration to boost low income residents’ job potentials and attempting to reduce income inequality.

The big change we expected and saw recently was MAS

loosening policy by slowing the pace of appreciation in the

SGD NEER. Inflation has fallen below 0% from lower oil and

property tightening measures. Core inflation remains

elevated at 1.5% but it will follow headline and ease

towards 1.0% and give room for more easing. We think in

the next meeting in April, MAS will re-center the mid-point

of the band to the current SGD NEER level (form of

devaluation), lower the appreciation path from 1.5% to 0%

and may even widen the band from +/-2% to 3% to allow

more flexibility. Also, interest rates are heavily influenced by

the US and will rise, which will also put downward pressure

on the economy and especially the property market that has

benefited from the low interest rate environment. This will be negative for the equity market as well.

Taiwan

Taiwan should benefit from an export recovery in the US

since exports are over 70% of GDP and sensitive to global

demand. Relations with China turned sour last year from

anti-China student protests but things are stabilizing and

trade should resume. However, the ruling KMT party is

losing more and more elections to the DPP who are more

anti-China and that will slow the rise in property prices and domestic demand.

TWD will also weaken from the stronger USD and the

central bank is likely content with a weaker TWD to support

growth and exports with very little inflationary pressure.

When the USD strength stabilizes, TWD will also be late in

appreciating since the central bank usually intervenes to

reduce the volatility. Hence, we see TWD to be a good short candidate against USD.

Thailand

Thailand’s economy will normalize since the military has

taken over the economy and protests that have been

disrupting the economy have stopped. We see the economy

recovering to 3.5% in 2015 after a dismal 0.8% growth in

2014. Consumption will rebound from people returning to

work and to the stores. Public investment will also rise as

government deadlock ends and the military has full

authority to reallocated funds. Tourism should return and help the small and medium sized enterprises.

22


Our top short in Asia for 2015 is THB based on three

reasons. First, we think THB is over-valued relative from

strong performance in 2014. With a weak economy, the

interim government will support a weak currency to restart

exports. Second, the central bank will ease policy by 50bps

to restart the economy. Inflation has been falling and policy

rates can be cut to restart the engine. Third, political risk

has not disappeared, but has just been pushed back. Until

Thailand has elections and the elected government is

accepted by the public, protestors can easily be back on the

streets. Until the political system is resolved, long term economic growth will be difficult.

Emerging Europe

Czech Republic

We forecast EUR/CZK to trade at 27.5 over the coming 12

months. The Czech National Bank’s (CNB) EUR/CZK floor at

27.0 will remain in place at least until mid-2016. If anything,

the CNB will raise the floor, if we see substantial weakening in PLN, HUF and RON.

In December and January, inflation retreated back to 0.1%

y/y after being on an upward trend since last summer. CPI

has stalled due to deflation stemming from the Eurozone. In

addition, there is still plenty of spare capacity and

continued high unemployment, 7.5% in February, which

keeps a lid on wage increases. Due to the global

disinflation, we believe inflation will remain subdued during

2015. The inflation target (2% +/-1%) will be difficult to

reach as long as the euro remains weak. The repurchase

rate is already close to zero (0.05%), leaving the CNB with

few options but to alter its cap on the exchange rate to avoid deflation.

GDP grew modestly by 1.5% y/y in Q4’14 compared to

2.4% y/y in Q3. Manufacturing is the backbone of the

economy and grew by 6.9% y/y 2014. Exports are

important, in particular to the German market, which has

been the main driver of economic recovery. However,

domestic demand has picked up lately, supported by

declining (but still high) unemployment, increased

minimum wage and a lower VAT rate for certain items.

When looking at retail sales, households are spending more

as we saw an increase to 5.9% in 2014, up from 5.2% in

2013. For these reasons, we expect GDP to pick up to 2.4% in 2015 and 2.9% in 2016.

With ECB’s quantitative easing program launched (€60bn

per month), several countries in Europe with pegs or semi-

pegs to the euro have acted pre-emptively. The Swiss

National Bank let go of its 1.20 floor and the Danish Central

Bank introduced negative interest rates, in order reduce

pressure on their currencies to appreciate. This has led to

speculations that the CNB will also abolish its semi-peg.

However, there are significant differences to keep in mind

when comparing the CZK with CHF and DKK. First, given

that the Czech Republic is not a safe haven, the koruna

does not face the same upward pressure as, e.g., CHF and

DKK. Second, the exchange rate floor has only had a

moderate impact on the (in comparison small) CNB’s

balance sheet. Third, due to legal complications,

introducing negative interest rates has been ruled out by

policymakers. Hence, if anything, it is more likely that the

floor is raised as we see an increasing need to further loosen the monetary policy.

Hungary

We forecast EUR/HUF to reach 313 during Q1’15 and

starting in Q2, we expect the forint to begin to strengthen,

taking the pair down to 300 in one years’ time. The

Hungarian economy is undergoing a fragile recovery, but

the upcoming ECB easing program (€60bn per month) will contribute to HUF appreciation against the euro.

CPI has showed deflation since September (latest print: -1%

y/y in February) and we expect it to continue to hover in this

territory due to global deflationary pressures, a negative

output gap and subdued import prices. For these reasons,

we expect the 3% inflation target to be reached in 2017 at the earliest.

23


The Hungarian economy grew by 3.4% y/y during 2014

supported by an increase in investments and private

consumption. Above-trend growth was supported by two

temporary factors: frontloaded spending of EU structural

funds and a strong year for the agricultural sector. We

expect GDP growth to normalize to 2.5% during 2015 for

three reasons: 1) base effects, 2) the ECBs QE program and 3) new easing cycle, taking the base rate down to 1.6%.

The National Bank of Hungary (NBH) has left the base rate

unchanged at 2.10% since July 2014. However, following

ECB, Poland and possibly the Czech Republic and Romania,

we expect the NBH to start a new easing cycle and cut by

20bps at their next meeting on March 24th. With deflation

in the economy, the CPI and the HUF are on the CBs radar

and if it falls further, looser monetary policy is in the cards.

Given that the ECB has cut its rate and is about to roll out a

large stimulus package, we believe the NBH will follow suit

and cut rates by 50bps to 1.6% during Q2 in order to stabilise the forint vs. the euro and to stem deflation.

Hungarian households have HUF 3.5trn of mortgages

denominated in Swiss franc. The loans were taken in the

boom years before the crisis in 2008 due to attractive Swiss

rates and expectations of a stronger forint. Luckily for the

households, the Forint has not suffered that much after the

Swiss National Bank de-pegged the franc from the euro in

January as, the exchange rate from CHF to HUF was set

already in November. Hence, the impact has been limited, unlike the situation the neighboring country Poland.

Poland

We forecast EUR/PLN to trade in the range between 4.10

and 4.20 throughout the year. Growth has been weak and

inflation low but economic activity is picking up and

fundamentals look strong. However, the slowdown in the

Euro area and geopolitical woes are putting a lid on

Poland’s growth potential. Therefore, we expect GDP growth to remain at 3% in 2015.

As the other countries in Eastern Europe, Poland has a

deflationary price pressure, well below the 2.5% +/-1%

target. In January, CPI printed -1.3% y/y. The National Bank

of Poland (NBP) expects inflation to stay below target until

2017. This has been the main reason for cutting the base

rate; 50 bps in October and another 50bps in March taking

the rate down to 1.5%. We expect the base rate to remain at

this level until Q4’15, as NBP has stated that the easing cycle is over.

As in Hungary, Polish households took up mortgages in CHF

in 2006-2007. Unlike Hungary however, Polish borrowers

are exposed to movements in CHF/PLN as a conversion rate

has not been set. Compared to Hungary, the percentage of

total mortgages in Poland is smaller (PLN 131bn) and CHF

lending was restricted to only very solid Polish borrowers.

Hence, there is rather limited need for damage control in

Poland but, the situation has still caused plenty of protests

and law suits, primarily against banks as they are viewed to

have tricked customers. This is starting to become a

political issue in Poland as borrowers want the government to force banks to take a larger hit.

On October 25th, Poland will hold parliamentary elections.

It will be a tight race between the incumbent party Civic

Platform, a Christian democratic party, and Law and Justice,

a conservative and populist party. Read more on the upcoming election in the Election Monitor on page 18.

24


PLN TECH CORNER

The market is confined to an “ever contracting” range. The

"Triangle" should be a long-term bullish formation, but it

has failed to deliver numerous times and sideways trading

outside the range would force reassessment and a

4.09\4.40 “Box” considered instead. Outside this “Box”

there is more support at 4.03 and resistance at 4.43 to

violate to foresee a fresh trend beyond the very short-term

perspective.

Romania

We expect the Ron to strengthen gradually in 2015, taking

EUR/RON down from the current 4.45 level to 4.30 in Q1’16.

The Romanian economy will benefit from ECBs easing

program, lower domestic interest rates, lower taxes as well as low inflation.

As in many other countries in Eastern Europe, Romania is

experiencing downward pressure on inflation. In February, it

printed 0.4%, far below the National Bank of Romania’s

(NBR) 2.5% +/-1% target range. Falling oil prices and global

deflation pressure are the main contributors. We expect

inflation to continue to ease as ECBs QE program is rolled

out and oil prices likely to remain subdued. The NBH is likely

to continue on its easing path that was resumed last

August. The rate is currently at record low of 2.25% and in

order to curb falling prices and boost growth, we pencil in

further cuts this year. Another 25bps is expected, taking the rate down to 2% in Q2.

GDP growth is expected to stay flat at 3% during 2015. We

see three factors in support of a recovery. First, the easing

cycle will continue in order to combat disinflation. Second,

once budget revenues increase enough to allow tax cuts

without impacting the deficit, the government will lower

several taxes, among others the VAT from 24% to 20%.

Third, inflation will remain low and wage growth will be

significant, which will boost consumer spending, the key

driver of growth in Romania. However, the economy is also

very dependent on the Eurozone with 70% of exports going

to the area. A potential European downturn will hurt the Romanian recovery.

Since September 2013, Romania has a precautionary

standby agreement with the IMF worth €2bn. Lower taxes

and increased spending is not compliant with the IMF’s

demands as they wish to see a cautious fiscal policy and a

continuation of structural reforms. Romanian authorities

have failed several times to reach an agreement with the

IMF on the arrangement that expires in September.

However, this disagreement should not pose a major threat

as the financial markets have sailed through the Ukraine

crisis relatively unscathed and with an upbeat economic outlook, investors will stay optimistic.

Russia

We expect the correlation between RUB and oil prices to

remain strong throughout the year. Given the risk of

renewed pressure on oil in 2Q’15, before oil demand

catches up with supply, USD/RUB may again move up to

67.0 in the short term. However, with oil prices expected to

recover towards $70 per barrel towards the end of the year,

USD/RUB should fall back to 55.0. The forecast is also

predicated on the assumption that the conflict in eastern

Ukraine remains largely frozen and that Russia does not

intervene militarily and occupy a larger territory more

openly than it currently does. Such a scenario could draw

much more severe sanctions, and would likely send the RUB tumbling again.

25


Russia is facing a severe recession with real GDP expected

to contract by 5.5% in 2015 and by 1% 2016. The fall in the

price of oil and the RUB in combination with counter

sanctions on imports of food have caused inflation to soar

to almost 17% y/y in February. Real wages will take a severe

hit causing a sharp contraction in consumption. However,

the outlook for investment is not much better due to

continued Western sanctions on banks, oil-exploration

technologies, and a very poor business climate. The central

bank will likely cut the policy rate gradually over the course

of year, as it has had virtually no effect on the RUB. A

contraction of domestic demand will ensure that the current

account continues to record a surplus. However, it will be

offset by large capital outflows, ensuring continued pressure on reserves.

RUB TECH CORNER

The December–March contracting range is thought to be a

medium-term bullish continuation formation, which would

host a very ambitious upside objective — depending on

where the range breakout actually happens — if it is broken.

The target is currently obscured as a “known unknown”.

The (shallow) ”C-wave low” in this formation may or may

not be in place at 59.30 (which would be better understood

on a bullish initiative over 64.21) or it remains to be printed

closer to a short-term 78.6% Fibo retracement ref at 55.97.

In any case, it is a bullish setup waiting for a rouble

“accident” to happen through a later break above 71.80 and later also 78.00.

Turkey

We forecast USD/TRY to reach 2.70 in Q2, 2.77 in Q3 and

2.80 in Q4, implying a modest 2.5% depreciation against

the EUR. The TRY will benefit from low oil prices, which will

help contain the current account deficit. However, this will

not be enough to counter its vulnerability to external

financing conditions stemming from its elevated inflation, political risk and large current account deficit.

Turkey is one of the largest net importers of energy (5% of

GDP) among Emerging Markets. The slump in oil prices will

narrow the country’s current account deficit, push down

inflation, lower interest rates and boost private sector credit

growth. Lower oil prices will also free up public spending,

which will be reallocated from heavily subsidised

households energy bills into other parts of the economy.

However, the dependence on short-term portfolio inflows

to finance the large current account deficit (5.5% of GDP)

will ensure that the lira remains vulnerable to global capital flows.

The depreciation of the lira against the dollar raises

concerns over the servicing costs of the high level dollar

denominated debt. At the same time, lira weakness against

the dollar will not translate directly into an improvement in

export competitiveness due to the weakness of the euro.

Little incentive to deal with the situation exists as the

country is heading into general elections in June. Policy

rates are likely to remain too low, ensuring that inflation

remains uncomfortably high, putting a cap on real wages

and rekindling worries of a private sector credit bubble. To

lift growth in the longer perspective investments and

structural reforms are necessary. We expect GDP growth of 3.3% 2015 and 4.2% in 2016.

Inflation increased by 7.6% y/y in January, well above the

CBRT’s 5% target. It is driven by the depreciation of the lira,

low level of economic slack and lack of confidence in

CBRT’s independence and commitment to the inflation

target. The slump in oil prices will slow inflation but core

inflation will remain uncomfortably high (8.6% y/y in

January). The intense political pressure on CBRT will likely

remain until EUR/TRY reaches roughly 2.95, that is only

slightly above the average rate in 2014. We expect the

CBRT to loosen monetary policy further until Q2, after

which it will be forced to hike once Fed initiates its hiking

cycle. The CBRT will react primarily to capital flows (TRY fluctuations), not inflation.

Turkey will hold general elections on June 7th. The

incumbent President, Tayyip Erdogan, is seeking a

supermajority in parliament. He has made no secret of

wanting to amend the constitution to increase the power of

the president. Erdogan is the founder of the AK Party, which

currently holds 313 of the 550 seats in parliament. He will

try to boost his popularity ahead of the election by

26


providing fiscal and monetary stimulus. It will result in a

widening of the current account and budget deficits, as well as accelerating inflation and further lira weakness.

TRY TECH CORNER

The long-term uptrend is solid. The upper end of the trend-

channel may slow things down temporarily but a break

above 2.70 should be expected for transportation towards

interesting long-term Fibos at 3.10\3.15. Support is likely strong just south of the 2.40 mark.

Ukraine

On March 11, the IMF Executive Board approved a new $17.5

billion, four-year Extended Fund Facility (EFF) for Ukraine,

setting off $5 billion for immediate release. The approval

will provide some support for the battered UAH, but with

reserves remaining very low and with the loss of key export

industries to the rebels in the Donbass region, pressure on

the UAH will remain throughout the year. We see USD/UAH averaging around 30.0 in 2015.

Ukraine is facing a full-blown economic crisis with inflation

accelerating to 25% last year. The IMF expects real GDP to

contract by 5.5% in 2015, but we think that the risks are

skewed to the downside. The IMF also forecasts inflation to

be 27% in 2015, while the current account deficit should

narrow to less than 2% of GDP, due to the sharp

depreciation of the exchange rate causing a sharp

contraction of domestic demand. Fiscal adjustment will also

hold back GDP, and will present a severe drag on economic

activity for several years with public, and publicly

guaranteed debt peaking at close to 95% of GDP in 2015.

The IMF program assumes that private creditors will

contribute funds to the government by restructuring existing debt. However, no deal has been announced yet.

Latin America

Brazil

We forecast USD/BRL to reach 3.20 in Q2, 3.30 in Q3 and

3.40 in Q4. The BRL will remain under pressure by weak

economic growth, US rate hike expectations, tighter fiscal

and monetary policies, power rationing, looming credit

rating downgrades, corruption scandals and concerns over the governments’ ability to consolidate public finances.

The government is cutting fiscal spending, subsidies and

private sector lending to deal with the deterioration of the

fiscal accounts and BRL weakness. In the short term this will

accelerate price increases further, weaken economic growth

and weigh on the currency. In addition, the country is

experiencing its worst draught in 80 years. Its heavy

dependence on hydropower makes power rationing a

probable scenario this year, which will shave off 0.5%–

1.0% of GDP growth. We expect growth to contract by

0.5% in 2015 and expand by 1.5% in 2016. In the long term, growth will be driven by a cyclical rebound.

Hopes are set high on the government improving its fiscal

stance after the appointment of Joacquim Levy as the

Finance Minister and Nelson Barbosa as the Budget and

Planning Minister. They have already launched an austerity

programme including fuel tax hikes, subsidies cuts and

tighter credit policies. However, efforts may be undermined

by the Petrobras corruption scandal, which reduces the government’s influence over congress.

27


Inflation has been accelerating reaching 7.7% y/y in

February, above the 4.5% +/-2% target band. It has been

driven by structural bottlenecks such as a weak

infrastructure network and a high level of inflation

indexation, as well as pass-through effects from BRL

weakness and fuel tax hikes. The slump in oil prices is

unlikely to have a significant impact on inflation since fuel

prices are regulated by the government. We see inflation

averaging above the 6.5% upper target limit in 2015. This

will ensure that monetary policy remains tight. We believe

the Selic rate will be hiked by 50bps to 13.25% in Q2, before peaking at 14.0% by the end of the year.

After widening from 2.1% in August 2012, Brazil’s current

account deficit appears to be stabilising around 4.0% of

GDP. The main cause of the break in the widening trend is

the depreciation of the BRL, which has increased the

competitiveness of the domestic industry. Tighter fiscal and

monetary policies will also help contain the current account

deficit going forward. However, a key risk to the capital

account is the upcoming US rate hike which makes capital inflows harder to attract.

BRL TECH CORNER

The recent move through resistance at 2.47 & 2.65 (now

presumably strong support together with long-term

dynamic supports in this area) has opened up the path back

towards the 2002 high of 3.9650. Short-term conditions

look stretched, but few seems to care and as long as more

pronounced signs of a sellers’ response (other than in the

dailies) do not show, extension is likely towards refs at 3.27 and 3.44.

Chile

We forecast USD/CLP to reach 650 in Q2, 660 in Q3 and

670 in Q4. The peso is highly correlated to the copper price

which has been falling since 2011. The decline has

deteriorated Chile’s terms of trade, resulting in lower export

revenues and weaker domestic demand. Strong wage

growth together with stable unemployment and low oil

prices will lift domestic demand this year, although it will not be enough to stop the pesos descent.

Economic growth has suffered from the decline in copper

prices. The copper industry represents almost 20% of GDP

and two thirds of total exports. The trend is unlikely to

reverse as exports to China, representing 8% of GDP, is

starting to soften as its demand for metals is decreasing

amid the slowdown in the property sector. However, the

effect of lower copper prices will be partly offset by the

slump in oil prices as Chile is the region’s largest net energy

importer. The economy will receive little support from the

robust recovery in the US, since it only accounts for 13% of

total exports while 39% are destined to the EU and China.

The budget deficit looks set widen as the government will

increase public spending by almost 10% this year to jump

start the economy. The main targets are infrastructure,

education and healthcare. It will be financed by hiking

taxes, amongst others increasing corporate taxes to 27%

from 20%. Strong wage growth together with stable

unemployment and monetary easing will support domestic

demand and economic growth this year. We forecast GDP to increase by 2.5% this year and 3.8% in 2016.

Chile’s inflation increased to 4.5% y/y in January, above the

central bank’s 3% +/-1% target, from 3.0% y/y a year

earlier. It has been driven by higher food prices, a weaker

peso and loose monetary policy. The peso has depreciated

12% against the dollar since June, while the central bank

has cut the policy rate by 100bps to 3.00%. The cuts signal

28


that the central bank is currently more concerned with low

growth than above-target inflation. However, high inflation

limits the scope for further monetary easing. We expect the

central bank to keep the policy rate unchanged at 3.00% until Q4’15, when tightening should begin.

A strong peso and low competitiveness left the current

account deficit at 3.4% of GDP in 2013, which together with

negative net FDI made the peso vulnerable to external

shocks. However, the currency’s depreciation over the past

two years has improved the trade balance and the current account deficit has narrowed to 1.9% of GDP in Q3’14.

Mexico

We forecast USD/MXN to reach 14.70 in Q2, 14.40 in Q3

and 14.10 in Q4. The MXN will benefit from the pickup in US

activity, reform initiatives and tighter monetary policy. A low

oil price is a key risk as it forces cuts in fiscal spending to

replace lost tax revenues. It also reduces the appetite to invest in the energy sector.

Mexico is particularly well placed to gain from the recovery

in the US economy. More than three-quarters of exports are

destined to the US, representing 25% of GDP. In addition,

President Enrique Peña Nieto has set in motion a wide-

ranging reform program including fiscal, education,

telecom, banking, labour, judicial, electoral, and, most

importantly, energy sector reforms. However, if oil prices

averages USD 50pb, government revenues from the energy

sector will decrease by 25% (2% of GDP). The government

has already announced spending cuts of 0.7% of GDP this

year, but may be forced to cut further to prevent the budget

deficit (roughly 4% of GDP in 2014) to spiral in 2016, when the government’s oil prices hedges will have to be renewed.

Lower oil prices may also reduce investors’ appetite to

participate in auctions of exploration blocks that are

relatively expensive to develop. Investments have also been

dented by corruption allegations and security concerns. We

expect GDP growth to expand by 3.3% in 2015 and 4.0% in

2016. It will be driven by a cyclical rebound supported by

strong US demand and implementation of structural reforms.

Inflation reached 3.1% y/y in January, just above the 3%

inflation target. We don’t believe that inflation will be a

concern to the central bank this year as GDP growth is

insufficient to generate any significant price pressure. In

addition, low oil prices, fiscal spending cuts and last year’s

tax hike falling out of the annual reading will cap prices. We

think that that the central bank will keep its policy rate on

hold at 3.00% until Q3. Concerns over peso weakness

stemming from a tighter US monetary policy will force the bank to hike rates by 50bps in Q3 and 25bps in Q4.

MXN TECH CORNER

The 2009 high has just been violated. An earlier bullish

"Triangle" breakout posts an ambitious 18.00 objective, but

levels at 16.97\17.22 also works fine as a tentative target

area, if remaining resistance at 15.89 is erased. Medium-

term support is likely strong in the 15.55/14.43-area,

centring on the June 2012 high of 14.60.

29


Sub-Saharan Africa

Botswana

The Botswana pula operates under a crawling peg

arrangement against a basket consisting of 50% ZAR and

50% SDR currencies. We expect USD/BWP to trade higher this year on the back of ZAR weakness.

Botswana is the world’s largest diamond producer. Fuels

and mining products represents 85% of total exports and

65% are destined to the European Union. This makes the

economy inherently exposed to commodity prices and the

recovery in the Europe. The diamond industry is expected to

be exhausted within 20-30 years, making economic

diversification vital. The non-mining sector is struggling due

to disruption in water and electricity supply as well as high

unemployment and income inequalities. Investments in

infrastructure and the labour together with efforts to

diversify the economy will partly offset the effects of the

slowdown in the diamond sector. We expect GDP to grow

by 4% this year driven by a cyclical recovery in the mining sector.

Inflation softened to 3.6% y/y in January from 4.5% y/y in

September on the back of lower oil prices and modest

domestic demand. The lower price pressure prompted the

Bank of Botswana (BoB) to cut its policy rate by 100bps to

6.50% in Q1’15. The BoB targets inflation at 3%¬–6% and

we will likely receive additional accommodative measures from the bank in H1’15.

Ghana

The cedi will continue to depreciate against the dollar this

year as it is weighed by stubbornly high inflation and large

current account and budget deficits. Fiscal and monetary

policies will likely not be tight enough ahead of the 2016 general elections.

Economic growth has been supported in recent years by the

start of oil production, ample fiscal spending and rapid

credit growth. The budget deficit ballooned to 7% of GDP in

2014 and the current account deficit is likely to widen from

9.4% of GDP in 2014 due to the slump in commodity prices.

This has resulted in credit rating downgrades and made

fiscal consolidation vital to restore investor’s confidence.

The government has taken steps to rein in spending and

increase revenues in the 2015 budget including wage and

hiring freezes, VAT hikes, and subsidy cuts. In addition, the

country is to finalize a deal with the IMF for a USD 1bn

multi-year loan facility conditional to improved fiscal

discipline. However, strong labor unions and the 2016

election make the complete implementation of the

proposed fiscal measures improbable. Electricity disruption,

high unemployment and income inequalities will provide a

further drag on growth this year. In the long term, growth

will be supported by a cyclical rebound in commodity prices

and stronger foreign demand. We believe GDP will increase by 4% in 2014.

Inflation increased by 16.4% y/y in January, well above the

8% +/-2% target. It has been driven by the sharp

depreciation of the GHS, subsidy cuts, fiscal spending and

credit growth. The policy rate is currently kept at 21% and is

unlikely to be loosened significantly this year as the slump

in oil prices will begin to fall out of the annual inflation numbers in H2.

Kenya

We forecast USD/KES to follow its long term trend and

reach 92 in Q2, 93 in Q3 and 94 in Q4. Security concerns,

following last year’s terrorist attacks, has caused a sharp

drop in tourism and hit the economy hard. The current

account and budget deficit remains large which makes the

country vulnerable to external shocks. However, most

sectors of the economy are experiencing robust growth which supports stability.

Last year’s terrorist attacks by the Islamic militant group Al

Shabab shaved off 3% of GDP in Q3 as several countries

issued travel warnings to Kenya. Furthermore, it reduced

investors’ confidence and lowered foreign capital inflows

which put pressure on the shilling. Steps have been taken to

improve the security situation, including the nominations of

a new Police Inspector General and removal of corrupt

leaders. The economy is one of the most diversified in the

region although the agriculture sector is large (25% of

GDP), making it exposed to weather conditions. The main

drivers of growth are; rising foreign investments, stronger

foreign demand and a recovery in the tourism industry. The

currency’s vulnerability to capital flows stems from its large

current account and budget deficits (8% and 6%

respectively). The USD 2.75 Eurobond issue, to help fund

infrastructure projects, together with the USD 688mn

precautionary loan facility from IMF will improve investors’

confidence and financial stability. We expect GDP to increase by 5.8% in 2015 and 6.0% next year.

30


Inflation increased by 5.6% y/y in February and has been

falling since August on the back of lower oil prices despite

the depreciation of KES. Developments of oil prices and

weather conditions, due to the large agriculture sector, will

be the main drivers of prices this year. The central bank

kept its policy rate stable at 8.5% last year as inflation fell to

within the 5 +/- 2.5% target. The bank will keep its policy

rate tight this year due to the currency’s vulnerability to external financing conditions.

Nigeria

We forecast USD/NGN to stabilise at close to 200 in 2015.

The slump in oil prices has put pressure on fiscal accounts

which together with security concerns and corruption allegations has reduced investor confidence.

Nigeria has been hit hard by the slump in oil prices. It is the

sixth largest net oil exporter in the world with oil and mining

products accounting for 95% of exports. The fall in prices

has widened the fiscal deficit, which is expected to reach

2.8% this year, close to the 3% statutory limit. The current

account deficit will balloon to almost 7% of GDP in 2015.

However, the country will endure the downturn in oil prices

due to its low level of public debt and the room to raise

corporate taxes. Nevertheless, this year’s budget will be

trimmed by reducing capital spending in much-needed

infrastructure. This increases the urgency of the

implementation of structural reforms, but they are likely to

be delayed as the country is heading into general elections on March 28th, increasing political uncertainty.

Security concerns stemming from the insurgence of the

Islamic militant group Boko Haram in northeast Nigeria has

become an increasingly pressing matter as they step up

attacks and thefts from pipelines. We expect GDP to increase by 5.0% this year and 7.0% in 2016.

Inflation is remaining stable at uncomfortably high levels

(8.2% y/y in January) and is mainly driven by expansionary

fiscal and monetary policies. The price acceleration may

increase due to NGN depreciation, increased public

spending ahead of the election and the disruption of trade

flows following the insurgence of Boko Haram. The central

bank has raised the policy rate by 100bps to 13%, widened

FX fluctuation bands, increased reserve requirement and

tightened capital controls to defend the naira. We expect

further measures to be taken this year as the naira will likely

remain under pressure. The government delayed general

elections for six weeks to March 28th

due to security

concerns related to Boko Haram. The ruling People’s

Democratic Party (PDP) looks currently likely to win, but it

will be a very tight race against the newly-formed All Progressives Congress (APC).

South Africa

We forecast USD/ZAR to reach 11.95 in Q2, 12.20 in Q3 and

12.50 in Q4. ZAR is vulnerable to external financing

conditions stemming from its large budget and current

account deficits. Structural bottlenecks put a cap on growth

while power shortages, potential rating downgrades and

violent labour market disputes may exert additional

pressure on ZAR. The slump in oil prices provides some relief but will not be enough to stop ZAR depreciation.

Domestic demand has been the main driver of growth, but

it is now slowing due to decelerating credit growth to highly

indebted households. The current account has ballooned

after years of accommodative fiscal and monetary policies

which has made the currency vulnerable to external shocks

due to its dependence on short-term portfolio inflows. The

government has been largely ineffective in implementing an

investment based growth model following the post-

commodity boom era. The underlying problem is large

income inequalities and high unemployment (25%), which

reflects a highly fragmented society. Essentially there are

two South Africa; one poor, largely tribal-based and one rich

with living standards and education levels on par with Western Europe.

31


Structural reforms and investments are needed to lift

growth. However, parliament is politically fragmented and

investors’ confidence is low following rolling power

outages, strikes and credit rating downgrades. The slump in

oil prices has provided some relief by shrinking the current

account deficit, lowering interest rates and allowing for

potential fuel tax hikes. Nevertheless, the economic outlook

for the country remains dim. We expect GDP to increase by 2.2% in 2015 and 2.3% next year.

Inflation slowed to 4.4% y/y in January, within the 4%–6%

target range, driven by lower energy and food prices.

Nevertheless, core inflation remains elevated at 5.8% y/y.

The underlying price pressure stems from an inability of the

SARB to insulate the economy from the global business and

commodity cycles. Nevertheless, inflation expectations

remain stable in the medium term. SARB will likely keep

rates on hold for now, but will be forced to hike when the

US does. We believe that the SARB will start hiking the policy rate in Q3, and follow the Fed up.

32


Disclaimer

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