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A window of opportunity for the Emerging Markets

November 6, 2013

The Fed signaled that it would not start tapering its monetary stimulus this year.

Global Economy
Easier Monetary Conditions to Extend into 1Q14
We believe that the Fed will wait for stronger evidence of an improvement in economic activity, before reducing its monetary stimulus.

Brazil
Constraints for further fiscal expansion
The room for further fiscal and quasi-fiscal policy expansion has narrowed. Our 3Q13 GDP forecast went through a slight upward revision, contributing to a rise in our estimates for GDP growth in 2013 and 2014.  

Mexico
An Unbalanced Recovery
The economy is recovering, but growth has been unbalanced, with exports up and internal demand down. The lower house introduced positive changes in the tax reform bill.

Chile
Easing Cycle to Continue
Consumption decelerated in September and several fundamentals point to below-trend growth. The central bank cut the interest rate in October and there is more to come.

Peru
Growth Slows, Composition Changes
Growth continues to slow, but business confidence improved in September, indicating that the deceleration will not be steeper than contemplated in our scenario.

Colombia
An Important November on Peace Negotiations
November 18th is the deadline for the government and the FARC to announce a peace agreement. This is a key issue for President Santos to decide if he will be a candidate in next year’s elections.

Argentina
Falling Reserves and Political Shake-Up
The opposition gained an important victory against Kirchnerism in the mid-term election, on the road to the 2015 presidential election.

Commodities
We Expect an Additional Drop in Sugar Prices
Fundamentals explain just some of the past gains in sugar prices, so we expect further reversal in prices. WTI discount to Brent crude will probably remain wide until early 2014.

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A window of opportunity for the Emerging Markets

The Fed signaled that it would not start tapering its monetary stimulus this year. Economic data has been showing only a moderate recovery, particularly in the labor market. The Fed is likely to wait for stronger evidence of an improvement before reducing its monetary stimulus, probably in March next year. 

The Fed’s tapering delay and improving growth numbers in Europe and China have created a more favorable liquidity environment for emerging markets. Financial inflows resumed, opening room for lower interest rates, a stronger exchange rate or both.

In Latin America, Mexico and Chile reduced their interest rates in October, while Peru made another cut in its reserve requirements for local currency deposits. We expect further interest rate cuts in Chile and Colombia this year. The monetary policy reaction should help reverse the decelerating trend observed in the region. Country-specific factors, such as the tax reform approval in Mexico, a possible peace agreement with the FARC in Colombia, and a recovery in business confidence in Peru will also contribute to the reversal.

In Brazil, the higher global liquidity is reflected in the appreciation of the real, a movement that has been reinforced by the central bank’s FX derivatives sales program. We have maintained our forecast for the exchange rate by year-end at 2.35 reais per dollar. For the end of next year, our forecast is now 2.45 reais per dollar, from 2.55 previously. The current data suggests a slight improvement in economic activity, which led us to revise up our GDP growth 2014 from 1.7% to 1.9%. Higher interest rates and expected reduction of quasi-fiscal stimuli in 2014, however, cap the pace of recovery.

In Argentina, the highlight is the government's defeat in the October mid-term elections. The result makes it difficult for the government to pursue a constitutional reform that would allow Cristina Kirchner to be elected to a third term. Given the uncertainties regarding the economy and the loss of international reserves, we expect a further tightening of FX controls and acceleration in the official exchange rate depreciation.

Global Economy
Easier Monetary Conditions to Extend into 1Q14

• We expect the U.S. Fed to maintain the current pace of its monetary stimulus until March.

• Meanwhile, we forecast growth in the U.S. to improve in 2014, while China has confirmed better momentum in 2H13 and Europe continues to stabilize.

• With no material change in the world growth outlook, the prolonged monetary expansion in the U.S. should benefit emerging markets.

We now believe that the U.S. Fed will start tapering its asset-purchase program only in March (we previously expected this in December). There is little evidence that activity is improving in 4Q13, and the labor market has moderated in the second half of the year. We maintain our expectation that growth will accelerate to 2.5% in 2014 from 1.5% in 2013. But we believe that the Fed will wait for stronger evidence of an improvement before reducing its monetary stimulus.

China confirmed the pick-up in activity, with GDP up 7.8% yoy in 3Q13 compared with 7.5% in 2Q13. We see some moderation in 4Q13, but overall, China is more supportive for world growth in 2H13.

In Europe, Spain returned to growth in 3Q13 after nine quarters of contraction, another sign that the region has stabilized. Overall, the recovery in the euro zone is still incipient in an environment of very low inflation. But Europe now contributes to world growth instead of being a drag, as was the case until earlier this year.

With no material change in the world growth outlook, the prolonged monetary expansion from the U.S. Fed benefits emerging markets. Financial inflows reaccelerate, creating room for interest-rate cuts and/or for exchange-rate appreciation. Indeed, we believe that the central banks in Chile and Colombia will feel more comfortable to go ahead with a further rate cut this year, as we expect. And in Brazil, the global environment favors a more appreciated Real at the end of the year than we previously expected. Liquidity conditions would become less favorable next year, when the Fed finally goes ahead with the QE tapering.

U.S. Fed likely to maintain current stimulus pace until March 2014

The U.S. Congress agreed to fund the federal government until January 15 and suspend the debt limit until February 7. The solution came after a 16-day shutdown of the federal government that increased uncertainty and reduced the public sector output in 4Q13. Moreover, the fiscal uncertainty should remain relatively high at least until mid-January, when Congress has to approve the budget to avoid another shutdown and a longer-term debt ceiling.

The economic impact of October’s fiscal battle is not large but is enough to prevent the economy from accelerating significantly in 4Q13. We estimate that U.S. GDP grew 2.0% (seasonally adjusted annual rate – SAAR) in 3Q13. With the shutdown, we expect this moderate pace to continue in the 4Q13 (see graph).

In addition, the labor market was showing some weakness even before the shutdown. The 3-month-moving average of the non-farm payrolls decelerated to 143k per month in September. This is significantly lower than the 223k of last April (see graph), right before FOMC members started to signal a QE tapering this year.

We now believe that the Fed will start reducing the asset purchase program in March instead of December. A 2% (SAAR) GDP growth pace is below the FOMC forecast of 3% in 4Q13. We think the Fed would be more comfortable to start tapering once non-farm payrolls are over 180k, instead of the less-than-150k level seen recently. Moreover, the fiscal deal in October was short term and hence keeps some uncertainty for 1Q14. Finally, the shutdown has affected the collection and release of economic data, reducing the visibility of the pace of recovery. Overall, the economy doesn’t seem to have accelerated in 2H13 as might have been expected by the FOMC. We think that the economy will pick up in 2014, but the Fed will likely wait for strong evidence before slowing down its asset purchases.

We see balanced risks around the March tapering start. The last FOMC meeting statement reinforced that the asset-purchase program is data dependent. The economy could pick up in the coming months and Congress address the fiscal issue by mid-December, leading the FOMC to start tapering before March. However, there seems to be similar probability that the current economic fog will not clear until March, leading the FOMC maintain its monetary stimulus longer.

We lowered our forecast for the 10-year Treasury to 2.65% from 2.80% at the end of 2013 but keep it at 3.4% at the end of 2014. In terms of growth, we maintain GDP growth forecasts at 1.5% in 2013 and 2.5% in 2014.

China – Focus shifts to reforms as the pick-up in 3Q13 GDP is confirmed

China’s 3Q13 GDP was 7.8% yoy, in line with expectations. This represents a considerable increase in the pace of sequential growth to 8.8% qoq (SAAR) from 6.4% and 7.6% in 1Q13 and 2Q13, respectively.

Activity was strong in July and August, but has fizzled out slightly in September. September industrial production was 10.2% higher than one year ago, compared with 10.4% in August. Urban fixed-asset investment grew 20.2% year-to-date, compared with 20.3% in the previous month. Finally, retail sales were up 13.3% yoy in September compared with 13.4% in August.

The NBS Purchasing Managers’ Index (PMI) increased to 51.4 in October from 51.1 in September. The improvement suggests a good start to activity in 4Q13, although we still expect some moderation toward the end of the year.

With the 7.5% growth target for 2013 almost assured, policymakers in China are moving to a more neutral stance and focusing on structural reforms. Activity was better in 3Q13 as policymakers signaled more support to short-term activity after the slowdown seen in the first half. Now, the official 7.5% growth target for 2013 is all but assured. Hence, we see the PBoC fine-tuning its communication and liquidity policy to a more neutral stance in 4Q13, compared with 3Q13. Overall, policymakers have also shifted the emphasis of their statements toward maintenance of policies in 2H13 and a focus on structural reforms.

The Communist Party’s Third Plenary Session in November will be an important focal point for reforms. We do not expect to see details for implementation, but broad outlines for policy direction for the next few years. These will likely focus on the structure of the government, tax reforms, financial liberalization, the household registration system, measures to improve the productivity of the private sector and ways to increase the influence of market forces in the economy.

We maintain our growth forecasts at 7.7% and 7.3% for 2013 and 2014, respectively.

Spain returns to growth

In Spain, GDP increased 0.1% qoq in 3Q13 after nine quarters of contraction (see graph). Net exports are the main driver of growth in the country, but domestic demand is also stabilizing. We believe that Spain has exited its prolonged recession.

The country is the fourth largest economy in the euro area and was strongly hit by the debt crisis. We see its return to growth as another sign that the region has stabilized.

Euro zone’s inflation slows further, bringing back discussion of a rate cut

The euro zone’s CPI declined to 0.74% yoy in October from 1.10% in September. Lower energy and food inflation were the main culprits, but services inflation also weakened in the month. Overall, the picture of low inflation in the euro area has sharpened.

We see the ECB on hold, but this further decline in inflation from an already low level creates a significant risk of easing in December. Although the full breakdown of October’s CPI is not yet available, we suspect that one-off factors prevailed. If so, the ECB could look beyond this recent fall in inflation and stay put. However, the composite PMI in October declined to 51.5 from 52.2 in September. Given this very-low-inflation environment, another weak PMI in November would tilt the balance towards further easing.

Commodities – We expect an additional drop in sugar prices

The Itaú Commodity Index (ICI) remained roughly flat in October, falling 0.4% through the month. The breakdown shows small changes in all sub-indexes: agricultural (-1.8%), metals (0.5%) and energy (0.0%). Among single commodities, the main highlights were the rise of sugar and the fall of WTI crude oil prices.

Overall, there were no major data releases or changes to fundamentals in October to prompt strong moves in prices or adjustments to our forecasts. The fiscal uncertainty in the U.S. was resolved without a major impact in the growth outlook. The activity pickup in China was confirmed in 3Q13, but we (and the market consensus) continue to see it as temporary. Moreover, the shutdown of the federal government in the U.S. created a vacuum of commodity-specific data in the month. Major agencies, like the USDA, DOE and CFTC, have delayed their data releases.

Sugar prices rose a strong 7.5% until October 18, before reverting part of the gains and closing the month 1.0% up. The movement followed the 5.1% gain seen in September. The increase is consistent with the global deficit we forecast for the 2H13. But the outlook is for the global surplus to resume in 1H14. This explains the partial reverse in the end of October. We believe the adjustment is not over and, hence, we see additional drops in sugar prices ahead.

Supply conditions for corn and soybean improved, with favorable weather for the harvest in the U.S. and planting in Brazil. It didn’t change our forecasts, but it reduced upside risks to prices in both markets.

The Energy ICI remained unchanged as the increase in Brent prices was offset by the decline in WTI prices. The WTI discount to Brent widened to USD 12.0/bbl in late October from an average of USD 4.5/bbl in September as Crude oil surpluses returned to Central U.S. (i.e. inflows greater than use and outflows to the Gulf Coast and East Coast).  Outflow capacity is expected to outpace inflows only in 1Q14, hence the discount may remain above USD 8/bbl until the end of 2013. Meanwhile, Brent prices remained within the USD 106-110/bbl range. With a higher WTI-to-Brent discount in the short term, we now expect the ICI energy sub-index to increase 5.8% yoy in 2013 and fall 0.1% yoy in 2014 (previously: 6.6% and -0.8%, respectively). It is worth mentioning that our 2014 year-end level forecast remains the same.

Please open the attached pdf to read the full report and forecasts.



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