Investor sentiment at the IMF 2018 Spring Meetings was constructive, reflecting the still benign backdrop for emerging markets (EM), but risk tails now appear larger. While most concerns related to developed markets (DM), geopolitics and a busy election schedule are seen adding to EM event risk. Reflecting this more nuanced backdrop, there was a much stronger focus on stand-alone country stories than top-down beta drivers, a change from similar gatherings in recent years.
Selected Country Views:
China: Investors’ focus on China meetings was mostly concentrated on cyclical matters. This did not seem to owe only to some complacency about “trade wars”, but also to a sense that the issue is too intractable to express with any conviction presently. There was general praise for the quality of the “revamped” Chinese economic team and its commitment to pursue financial risk reduction. Still, there was also recognition that the growth performance amid the latter was made easier by a weak USD and robust external demand. Combined with the credit containment domestically, the expectation now is for moderately softer growth ahead. Surprisingly, there was less focus on “trade wars”. A general inability to diagnose the ultimate objectives of key players is prompting many investors to consider that scenarios in this regard are just too intractable for now.
Brazil: Brazil entered a phase where investors no longer can focus on benign cyclical dynamics while neglecting a potentially credit decisive upcoming election. The local yield curve looks set to stay steep until vote prospects are clearer. Two different camps were evident among investors in attendance. One camp feels markets are too complacent, not recognizing that a populist being elected President next October is a real possibility. The upshot is that the vital social security reform may not be passed and thus, unstable debt dynamics are a risk ahead so that all Brazilian assets need to incorporate more risk premia. The other camp feels that even if a non-traditional party candidate is the winner, he/she will be persuaded (possibly in part by a market selloff) of the need for such reform, so the inclination is to buy any selloff during the campaign. Polls look set to become key sentiment drivers ahead.
Russia: Investors valued the stance of Russian policymakers in the context of recent US sanctions. The strong policy framework conveyed confidence in Russia’s ability to deal with the related impact. Investors’ hope for a sanctions reprieve allowing reentry into (tactical) Russian positions was evident. Discussions focused on how Russia’s strong macro policy framework, anchored on predictable rules and targets, has served the country well and should be a core anchor facing new sanctions related pressure. Outside of that, there is confidence stemming from Russia’s rebuilt FX reserves position (USD462bn) and the fact that the budget was built on a $40.8 oil price assumption (such that sovereign funds continue to accumulate resources). The implication seems that if a sense of a more delayed sanctions pace takes hold, investors will return into Russian assets quickly, albeit in a much more tactical way.
Turkey: A packed meeting revealed investor hope that, anchored by early elections, Turkish assets can outperform ahead. However, conviction was not boosted by mixed signals from the meetings. There was general recognition that the June early elections are now Turkish authorities’ priority and stability into the vote (e.g. TRY) will likely be targeted. The Central Bank of Turkey’s actions will be a bellwether in this regard. A separate event risk in the background is Turkey’s reported decision to purchase Russian S400 missiles. The US threatened sanctions in this connection, so risk premia could be impacted by non-electoral dynamics as well.
Venezuela: The upcoming election is seen by investors as likely a non-event, while the much awaited regime change “from within” remains more of a hope than imminent prospect. Polls show apathy and frustration likely leading the opposition to abstain from voting on May 20. If so, Maduro could win free of fraud charges, in principle, limiting the scope for incremental foreign sanctions. Meanwhile, oil production, and hence foreign exchange earnings, continues to drop, with some estimates putting production as low as one million barrels per day by the end of year due to gross mismanagement, lack of maintenance and even equipment pillaging for sale (i.e. oil prices bring minimal relief to Venezuela). In the end, hyperinflation and shortages continue to provide an unstable situation that could lead to unrest and even regime change at any point.