Geopolitical risks linger but not all bad

Events in Ukraine and in particular Eastern Ukraine are deeply worrying and we have been arguing for some time that markets in general have been too complacent about the geopolitical risks. Therefore, we remain quite bearish on the outlook for both the Russian and the Ukrainian markets. In addition, we have revised our growth forecasts further for the Russian economy for 2014 and 2015.

However, while we are certainly concerned about a further escalation in the Ukraine- Russia conflict, we also stress that we do not think it is all bad for emerging markets in general.

We highlight several factors that in general we believe to be supportive for overall global emerging markets sentiment. First, the US economy continues to recover, as do the British and Japanese economies, which is supportive for overall global emerging markets sentiment. Second, while concerns about the Chinese economy persist, it is notable that Chinese policymakers have signalled that monetary policy could be eased to support growth. Third, we are putting some political risks behind us. Hence, with local elections in Turkey out of the way, investor concerns about political uncertainty seem to have eased. The same goes for the parliamentary elections in Hungary. Fourth, with the sell-off in emerging markets FX, fixed income and equity markets over the past year, emerging market assets in general can no longer be said to be overvalued. Fifth, a number of emerging markets (in many cases wrongly in our view) have moved to tighten monetary policy and short-term interest rates have increased. This higher carry – on for example the Turkish lira – is overall fairly supportive of the outlook for a number of emerging market currencies.

Concluding, while we are deeply concerned about events in Ukraine, we also see reasons not to panic over the impact of this on overall emerging markets sentiment and we are beginning to see good value in, for example, the South African rand.

• PLN: Geopolitics has moved to centre stage for the CEE currencies but for now the PLN is holding up. This said, Polish fundamentals are fairly strong which provides some support for the PLN. Longer term (six to 12 months), the PLN should stabilise at levels moderately weaker than the present level against the EUR.

• HUF: We continue to believe that Hungary’s fairly strong external position is likely to be supportive of the HUF in the medium term. As a consequence, we believe the HUF could even strengthen moderately against the EUR on a 12-month horizon, while the short-term outlook is likely to be dependent on the general emerging markets’ outlook. The biggest risk is the political uncertainty.

• CZK: The Czech central bank (CNB) remains committed to keeping the cap on the CZK at 27, at least until February next year. While we now do not think the CNB will lift the EUR/CZK floor higher as we assumed in our previous forecast, at the same time we believe the CNB will keep the cap beyond February 2015 as inflation will not increase as fast as it expects.

• RUB: We see downside risks to the RUB in the coming six months as the geopolitical situation weighs on capital outflow acceleration. The Fed’s steps to continue tapering, emerging markets turmoil and increasing liquidity in RUB markets are likely to keep the Russian currency under pressure.

• TRY: Continued fairly high inflation and a large current account deficit are likely to continue weighing on the lira over the longer term. However, these imbalances are largely already reflected in the lira and the lira continues to trade at what we consider to be fairly ‘cheap’ levels from a fundamental perspective. Furthermore, high Turkish interest rates are likely to provide some support for the lira ahead. Hence, while we expect further moderate depreciation of the lira, we are more bullish on the lira on a six- to 12-month horizon than market pricing currently indicates. Continued large macroeconomic imbalances, political risks and the overall fragile global emerging markets environment continue to be the key risks for the lira.

• ZAR: We are fairly upbeat on the rand but only in the short to medium term. Continued economic recovery in South Africa, rising commodity prices and higher carry should be supportive of the rand on a three- to six-month horizon. Over the long-term horizon of 12 months, we remain bearish on the rand given its fundamental overvaluation due to large external imbalances. The main risks to our forecasts include renewed turmoil in emerging markets and rising domestic socioeconomic problems.