Quarterly FX Forecast October - December 2016

Emerging markets

Looking ahead to the rest of 2016 Indonesia, Turkey, Malaysia, Brazil, Thailand, Nigeria, India, China, Mexico, Russia, Kazakhstan and Argentina

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Introduction As the pound languished and the Bank of England restarted its money-printing quantitative easing programme emerging market currencies were on a roll. The two events were not unrelated. With three central banks - the Bank of Japan, the European Central Bank and now the Old Lady too - on a bondbuying spree, the returns on those bonds were moving ever lower as their prices rose.

Note: In the following currency-bycurrency comments it is important to bear in mind that a good deal of the “strength” of EM currencies in Q3 was the result of the pound’s relative weakness. Over the three months, sterling fell by an average of -4.0% against the other dozen most actively traded currencies.

In July Germany issued 10-year bonds with a yield of -0.05%. Buyers gave the German government €1000 in the sure knowledge that they will receive only €999.50 when the bonds mature in 2026. The main reason for making such an “investment” is that some funds - notably pension funds - must hold GBP/NGN a proportion of their assets in instruments that provide GBP/MXN guaranteed liquidity and a GBP/CNH guaranteed return, however low. Not all investment funds have to follow such rules though, and those that don’t - hedge funds for example - were conducting an ever more frantic hunt for yield. They found it in emerging markets.

Average

High

Low

Range

408.86

452.60

364.02

±10.8%

24.64

25.79

23.28

±5.1%

8.77

8.97

8.56

±2.3%

GBP/ARS

19.63

20.18

18.89

±3.3%

GBP/MYR

5.32

5.47

5.14

±3.1%

GBP/TRY

3.90

4.08

3.75

±4.2%

GBP/INR

87.90

89.40

86.10

±1.9%

GBP/THB

45.74

46.75

44.57

±2.4%

GBP/IDR

17242.00

17619.00

16823.00

±2.3%

GBP/TZS

2873.00

2936.00

2816.00

±2.1%

GBP/RUB

84.83

89.19

81.66

±4.4%

GBP/BRL

4.263

4.427

4.069

±4.2%

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Looking ahead to the fourth quarter of 2016 Issues which could affect the Emerging Markets Russia

more sympathetic to capitalism and business. The real appreciated by 3.8% in Q3.

Shortly after Germany borrowed tenyear money for less than nothing, the Russian government went to the market with an issue yielding 3.6% a year. It raised $1.25bn in the sale proving a) that US sanctions are not wholly effective and b) that some investors are ready to turn a blind eye to alleged injustices when there is money to be made. Even if the Kremlin has not yet been rehabilitated the ruble seems to have been: it strengthened by 5.6% in the third quarter.

Argentina Argentina was blacklisted by the bond market for several years because of its previous administration’s default. It has now returned and will shortly issue a €500m ten-year government bond, yielding upwards of 7.5%, having already sold $20bn of US dollar-denominated paper this year. Investors are reassured by the government’s scrapping of exchange control and by other reforms. The removal of exchange controls cost the peso an instant third of its value at the end of last year but since then it has been roughly steady, and it went up by 4.3% in the last three months.

Brazil If Russian bond yields look attractive, consider Brazil, where the yield on sovereign bonds was recently 11.6%, whether the maturity was two years or ten. And it was not only the returns that attracted investors to the real: they were also fired up by the likely impeachment and dismissal from office of President Dilma Rousseff. It eventually happened at the end of August. While investors seem none too keen on her successor, Michel Temer, they believe he will be

Kazakhstan The tenge’s delinking from the US dollar last year brought pain to homeowners in Kazakhstan whose mortgages were denominated in dollars. A government

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Even so, with exchange controls and a managed tether to the US dollar it ticks at least a couple of the boxes. That would explain why it strengthened by 2.8% against sterling in Q3, a remarkably similar achievement to the dollar’s 2.3% gain.

scheme to refinance the loans in tenge has dealt with two-thirds of the twentyfour thousand people and businesses that requested help, according to the National Bank. That leaves around six thousand distressed borrowers, some of whom picketed banks in September demanding that their loans be refinanced in the local currency. The low oil price is causing trouble for Kazakhstan but, even so, the tenge has continued to recover from its January lows, and it rose by 4.5% in the third quarter.

Turkey Coups tend to make currencies less attractive to investors, even when they are unsuccessful. So it was with the lira after the attempted coup in mid-July: it lost 5% of its value in a week. It has subsequently recovered somewhat, but its overall performance in Q3 is slightly worse than that of sterling, with a -0.2% net loss.

Thailand A return to form saw the baht resuming its upward track against the US dollar, strengthening by a gentle 1% over the quarter. The currency gain probably owes more to commerce than to yield-hungry investors. And it recently emerged that the Thai government has decided to make future borrowings in yen, to take advantage of the lower rates involved. Over the three months, the baht went up by 4.7% against sterling.

Malaysia Quarterly growth of 0.7% is not classleading in the emerging market world so it is not wholly surprising that the ringgit was left behind by every major currency except sterling, where it scraped a feeble 0.4% gain. The outlook for Malaysia varies according to whose opinion it is: by some accounts, it will be the new South Korea but a Financial Times survey in September found Malaysians to be the most pessimistic of the five countries they canvassed, the other four being Indonesia, the Philippines, Thailand and Vietnam.

Indonesia The rupiah also racked up a 4.7% gain. Bank Indonesia, the central bank, cut its deposit rate in September but the resultant 4.25% is not massively less attractive than the 4.5% that preceded it.

Mexico

China

As soon as US presidential hopeful Donald Trump began talking of big beautiful walls, illegal aliens and

As the second-largest economy in the world, it is arguably disparaging to refer to China as an emerging market.

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protectionism the peso came under pressure. Between mid-August and mid-September, it weakened by 10% against the dollar. Then, after the first candidates’ debate resulted in a win for Hilary Clinton, the peso recovered a fifth of its earlier losses to book a quarterly decline of -1.2% against sterling. As far as investors are concerned, its fortunes will depend on who becomes the 45th president.

Nigeria The naira was the weakest performer among emerging market currencies in Q3, losing -4.5% to the pound. Since it was set free from its peg to the US dollar in late June it has been all over the place: at one point in August, the naira was down by -17%. The weakness is wholly due to the economic fundamentals: Nigeria’s economy is shrinking as a result of persistently low oil prices and, some say, governmental mismanagement.

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