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4 Jan 2016
EM: Differentiate investments in 2016 – Goldman Sachs
FXStreet (Delhi) – Research Team at Goldman Sachs, suggests that excessive deficits, slow growth will continue to weigh on FX in BRL, ZAR, COP while RUB, KRW (and eventually BRL) are friendly environments for lower rates and strong projected growth creates room for FX outperformance in INR, PLN, PHP.
Key Quotes
“In addition to global macro factors, domestic macroeconomic imbalances have driven much of the asset market differentiation across EMs in 2015 and, as we look into 2016, the disparate combinations of growth, inflation and current account gaps will continue to differentiate performance across EM FX and rates. We have developed a framework that allows us to estimate, for each EM, the impact of these three impulses on both the FX and rates markets in the year ahead. Based on this, we can identify three sets of conclusions:
First, we see the clearest scope for currency underperformance in BRL, ZAR and COP, where still large external deficits and moderate-to-weak real GDP growth will push towards currency weakness. In COP and ZAR, relatively firm headline inflation should also push towards higher front-end rates. Brazil is likely to enter 2016 at a very high level of inflation, but here we expect weak growth and the prospect of lower inflation to push towards lower BRL rates as the year progresses.
Second, Russia faces the strongest pressure for lower front-end rates, and the profile of recovering growth and a strong external balance argues for relative stability in the currency. Apart from Russia, our model estimates suggest that pressure for lower front-end rates will be felt most clearly in South Korea, given that growth is below trend and inflation is still well below target despite the pick-up we expect. Our economists have pencilled in 50bp of cuts in Korea; but, given weak exports and a capital outflow package in train, we also expect significant currency weakness as part of the easing in financial conditions.
Third, three countries make it into the quadrant with appreciation pressure in FX and upward pressure on rates: India, the Philippines and Poland. The common thread is balanced external accounts, strong projected growth and a pick-up in inflation. That said, it is hard to see policy rates being hiked in Poland given the upcoming change to the MPC in 2016Q1, so EUR/PLN downside (or PLN/HUF upside) may be a better way to position for the domestic macro impulses here. In India, we expect these dynamics to bring the rate-cutting cycle to an end for now; however, given the prospect of an outperforming currency, it remains a prime candidate for earning ‘good’ EM carry.”
Key Quotes
“In addition to global macro factors, domestic macroeconomic imbalances have driven much of the asset market differentiation across EMs in 2015 and, as we look into 2016, the disparate combinations of growth, inflation and current account gaps will continue to differentiate performance across EM FX and rates. We have developed a framework that allows us to estimate, for each EM, the impact of these three impulses on both the FX and rates markets in the year ahead. Based on this, we can identify three sets of conclusions:
First, we see the clearest scope for currency underperformance in BRL, ZAR and COP, where still large external deficits and moderate-to-weak real GDP growth will push towards currency weakness. In COP and ZAR, relatively firm headline inflation should also push towards higher front-end rates. Brazil is likely to enter 2016 at a very high level of inflation, but here we expect weak growth and the prospect of lower inflation to push towards lower BRL rates as the year progresses.
Second, Russia faces the strongest pressure for lower front-end rates, and the profile of recovering growth and a strong external balance argues for relative stability in the currency. Apart from Russia, our model estimates suggest that pressure for lower front-end rates will be felt most clearly in South Korea, given that growth is below trend and inflation is still well below target despite the pick-up we expect. Our economists have pencilled in 50bp of cuts in Korea; but, given weak exports and a capital outflow package in train, we also expect significant currency weakness as part of the easing in financial conditions.
Third, three countries make it into the quadrant with appreciation pressure in FX and upward pressure on rates: India, the Philippines and Poland. The common thread is balanced external accounts, strong projected growth and a pick-up in inflation. That said, it is hard to see policy rates being hiked in Poland given the upcoming change to the MPC in 2016Q1, so EUR/PLN downside (or PLN/HUF upside) may be a better way to position for the domestic macro impulses here. In India, we expect these dynamics to bring the rate-cutting cycle to an end for now; however, given the prospect of an outperforming currency, it remains a prime candidate for earning ‘good’ EM carry.”