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2020 Year in Review

 

The positive risk bias at the start of 2020 for EM Asia assets didn’t last long. The synchronised global economic upswing quickly unravelled as the COVID pandemic swept through EM Asia economies. The epicentre of the pandemic was in China to begin with and as China went into lockdown Q1 was a write off for economic growth in the region.

From a peak in mid-January to late March, the ADXY currency index lost 5%. There were significant divergences within the region though, with the IDR losing close to 15% against the USD, the baht 8.6% and INR 5.5%. IDR and INR are typically current account deficit currencies and sensitive to broader risk appetite, whilst the collapse in tourism inflows weighed heavily on the baht. In contrast, the PHP was basically flat against the USD in Q1, while the TWD only lost 0.67%. The Philippines has fairly limited offshore investor positioning, which served it well, while Taiwan managed the pandemic very well and this was reflected in relative currency outperformance.

Sentiment remained jittery through April into May, as the pandemic swept into the major developed economies. However, central bank actions started to calm markets. This was most evident from the US Federal Reserve, which presented a powerful backstop across multi asset classes. The supportive Fed action reduced the scramble for USDs, whilst in EM Asia central bank intervention via running down FX reserves helped stabilise currency markets. Policy support in terms of easier monetary policy and fiscal stimulus also helped. The average policy rate in the region now stands at 2.25%, including record low rates in Korea and Thailand at 0.5%. The regional effort was underpinned by China from a quantitative perspective, where the credit impulse turned aggressively higher.

The third quarter saw the recovery in EM Asia sentiment gather momentum. A number of factors contributed to this; COVID waves started to flatten out in most major economies, which allowed some return to normalcy from an economic growth standpoint. Policy stimulus was also in full swing by this stage and that was benefiting growth sensitive asset classes in EM Asia. In the FX space, the Chinese currency led the charge, up by 4%, the MYR up 3.1% and the KRW up 2.85%. THB remained a laggard (down -2.5%) as tourism flows were absent, while IDR slumped -4.1%, as foreign investors stayed away from the local bond market. We did see jitters in markets towards the end of quarter, as the US election came into focus, inducing profit taking after a very strong Q3 overall.

China remained a strong source of support during this period as its currency strengthened to offer an anchor point for the region as a whole. Capital inflow momentum accelerated into China as local investors flocked to Chinese bonds which offered a very attractive yield compared to other major markets. Export growth also recovered, particularly for those markets that rely on technology demand, which has been quite strong during the pandemic. Markets like South Korea, Taiwan, Singapore and to some extent China were the clear benefactors.

Into Q4 and the focus on the US election sharpened. The market started with the prospect of a so-called ‘Blue Wave’ democrat sweep of the Presidential office, Congress and Senate. In the event we only got 2 out of these 3 and the election result for the Presidential office was contested by the Trump administration. This produced some volatility in markets, but it didn’t prove long lasting.

With US political risk receding into the rear-view mirror, optimism for a global recovery in 2021 was boosted by successful vaccine trials. To date the rollout of the first of what seems likely to be several available vaccines has helped offset the impact of fresh COVID waves across the major developed economies, accompanied by lockdowns and movement restrictions likely to have a knock-on impact on growth for the quarter. Still, equity markets remain buoyant and commodity prices continue to trend higher. Data momentum is holding up well, adding to our view that recovery has legs into 2021, particularly if more vaccines can be deployed in the early weeks.

Moving focus to CEEMA and LatAm, 2020 opened with markets preoccupied with whether the US and China could implement a phase two trade deal in advance of the US election, which in those blissful days was seen as the dominant risk event.

Covid-19 first came to mass attention in January, but its impact on markets was initially limited as it was seen as a China issue. The Chinese province of Wuhan locked down on January 23,and by the 11 March the WHO declared a pandemic leading to the near global economic lockdown for most of Q2.

This led to the now familiar largescale sell off in risky assets and a sharp outflow from Emerging Markets funds in particular. The MSCI EM currency index dropped > 7% from Jan highs to March lows, but within that broad summary there were some laggards. RUB was the worst performing EM currency in the period, sliding over 23% vs the USD, followed by a group of LatAm currencies in the form of the Mxn, the Cop and the Brl.

Collapsing oil prices did the damage, headlines that proclaimed a 56% slump in Brent crude having an inevitable impact on confidence as the market retreated to its collective home office. However, worse was to come as Russia and Saudi Arabia failed to agree on production cuts, which led to the Saudis slashing prices in April and Brent crashing a vertiginous 77.75% from Jan to USD15.98/brl by early April.

The pandemic was matched by an unprecedented level of policy response from central banks and governments, underpinning impressive recovery which really accelerated as lockdowns ended in Q3.

The remainder of the year saw diverging Covid-19 success rates driving relative performance, led by China and Asia, before the US election took centre stage.

At time of writing (end of November) the MSCI EM currency index has rallied ca 9.5% from its March lows and in that period the Mexican Peso has been the biggest mover, with a +21.5% move higher vs USD, followed by the CZK and the ZAR.

The currency that struggled in this period was the TRY, as the CBRT continued to burn FX reserves and stay away from conventional rate hikes, whilst the threat of US sanctions and rising geo-political risks (Armenia/Azerbaijan and Eastern Med) continued to drive negative sentiment.

The RUB has also struggled to rebound, even as oil prices have rallied back to February levels. This is a function of the pre-US election trade which saw investors betting on the Biden victory and thus a renewed sanctions on Russia. At the same time this favoured the MXN, in a reversal of the 2016 Trump-trade.

The BRL has also underperformed, reflecting the country’s poor management of the Covid-19 pandemic and failure of the government this year to progress Brazil’s economic reform agenda after the 2019 pensions breakthrough.

Looking at year-to-date currency performance vs. the USD we can see that a few currencies have completely reversed March losses and now stand net stronger on the year. These include the CNY and KRW. However, many EM currencies are still heavily down, largely hit by weaker commodity prices, increased political risk, and external/budget imbalances.

So what might 2021 hold for EM?

The market is generally optimistic for 2021. The economic recovery is likely to extend and ultra-loose monetary policy in major economies, particularly the US, will persist - a negative for the USD.

We look to the following direction-setters:

  1. Pres Elect Biden’s transition into power. Will anything the outgoing Trump administration does in its last days of power upset market sentiment, particularly in relation to China?
  2. Who controls the US Senate? The run-off in Georgia in early January will be important. Democrat control of the Senate opens the way for greater fiscal stimulus, which is USD negative (all else equal) via the twin deficits. If Republicans hold control, fiscal stimulus is likely to be more limited but monetary policy may swing into action via the Fed / fresh QE.
  3. How quickly can a vaccine be rolled out, particularly for emerging economies? Arguably emerging markets outside EM Asia stand to benefit more from a vaccine, as most of EM Asia has controlled the pandemic well.
  4. Will China’s credit impulse start to wane and we will see activity momentum moderate?
  5. Can export growth elsewhere catch up to the better tech story seen in 2020?
  6. How will the Biden administration treat relations with China? Is there scope for more normal trade relations and less tariff rates? Anything that boosts global trade volumes should be a positive for EM Asia FX
  7. Will the Biden administration ask EM Asia countries to intervene less in their FX markets? If this transpires it will be supportive for EM Asia FX.

 

On balance, 2021 holds greater upside risks around the growth and capital inflow outlook for the EM Asia region. Our bias remains that this should generally support Asian currencies against the USD through the course of 2021.

As we have mentioned, consensus for 2021 is that Emerging Markets can lead an economic rebound in 2021 with the catalyst being a safe and effective Covid-19 vaccine. China should be the driver of export-oriented growth for EM with commodity-orientated open economies set to benefit the most.

Bullish Case

  • Global Economic Rebound - Emerging markets outperform due to a strong economic recovery, reversing the shock caused by the coronavirus crisis. This scenario relies on an accelerating cyclical vaccine-driven recovery.
  • Accommodative central banks – Global monetary policy remains extremely accommodative. US Fed policy in 2021 looks clear; it’s aim is to reflate the economy, drive investors along the credit curve and out of the USD. A global recovery and reflationary Fed policy both point to low rates across EM markets, a decline in the USD and strong inflows into emerging markets. EM bonds and FX should offer appealing carry, which should continue to attract inflows.
  • New US administration - President Biden should be positive for EM, as it is likely to imply a return to multilateralism and global trade, as well as a more predictable foreign policy.

 

Bearish Case

  • Flows do not materialize - there have been very few commentators backing a bearish view for Emerging Markets in 2021, with a global economic recovery the baked-in view. However, there are some that do not see EMs outperforming their developed market peers and would stay invested in US assets rather than EM.
  • US-China tensions - these will not disappear under the Biden Presidency (they existed pre- Trump) and remain a source of uncertainty.
  • EM fiscal and debt outlooks deteriorated as a result of the pandemic and will need to be rectified at some point.
  • EM countries may roll out the vaccines later than developed markets, meaning growth in EM could significantly lag that in DM.
  • It can be argued that the vaccine and growth normalization narrative is already priced into the markets, and that any of the above could lead to disappointment for EM currencies in 2021.

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