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Emerging Markets outlook

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Third round to the CEE bears?

Thu, Feb 1 2007, 11:56 GMT
by Danske Research EmergingMarkets Team

Danske Bank A/S

In the previous edition of Emerging Markets Briefer we suggested that the Central and Eastern European markets would lose momentum relative to the LATAM and Emerging Asian markets on the back of rising optimism about the US economy relative to Europe. Economic data released during January have clearly supported this view . with US numbers continuing to surprise on the upside, while European data have generally been fairly soft. This ongoing shift in the perception US vs. European growth has likely been one of the main reasons behind the sell-off in CEE currencies in recent months. And indeed a look at charts 1 and 7 below clearly shows that that the key driver in EM FX markets over the past month has been EUR/USD sensitivity. The top performers were mostly the Emerging Asian currencies, which normally tend to correlate positively with the USD.

 Looking ahead, we think January.s theme is likely to carry on into February, as we see the US economy continuing to surprise on the upside, while we expect the European economic data to point moderately down. Therefore, we continue to recommend being short in the CEE markets and, in general, long in the USD-sensitive markets . especially in Emerging Asia, but also on a more selective basis in the LATAM currencies. Meanwhile, we are, however, concerned about increasingly populist policies in certain LATAM countries, like Venezuela and Ecuador. Focus in LATAM will probably centre on the Ecuadorian debt payments due on February 15 . will payment be made (on time)? Fears of an Ecuadorean default are likely to rise further.    January.s jitters were generally confined to the core CEE countries, but we think there is a risk the sell-off might spread in February. We would especially watch some of the currencies that .avoided. the January tumble, particularly a number of the high-yielders, such as the Turkish lira and the Brazilian real. We would definitely also watch the Romania leu, which until now has outperformed the core CEE currencies.

  Given the high interest-rate sensitivity of both the BRL and TRY, one could expect the approximately 50bp rise in US 10y bond yields over the past two months to weigh on these currencies. Hence, given the prospects of a further rise in US bond yields during February, the sell-off could spread to the CEE high-yielders as well. Also worth noting is that the rise in US bond yields since the beginning of December corresponds to about half the rise that preceded the Emerging Market turmoil witnessed in May-July last year. This alone should make investors more cautious, and we obviously recommend not being overly exposed to high-yielders in February. A joker in the month ahead will again be the market.s favourite funding currencies . the JPY and CHF. Both currencies have continued to weaken, but policymakers around the world are clearly concerned about this trend and we would expect the weakness of, especially, the JPY to come up at next week.s G7 meeting.

 Keep track, too, of renewed speculation concerning a revaluation of some Gulf state currencies, most notably the Kuwaiti dinar. Such speculation could benefit the MEA currencies . especially the EGP.

• Download full Emerging Markets outlook

Published on  Thu, Feb 1 2007, 11:59 GMT