According to Benoît Anne of Societe Generale, the ongoing repricing of U.S. monetary policy is clearly the most serious risk for the global emerging markets in the period ahead. But a serious growth accident in China is not far behind in terms of a potential risk appetite shock for the Global Emerging Market. To a large extent, the Global Emerging Markets needs an improvement in global growth expectations to prosper. Weaker growth in China would sap global growth expectations, undermining Global Emerging Market assets which are highly leveraged to the global growth outlook. It would also push Emerging Market central banks to accelerate their shift to further policy easing, even in countries where there is no easing bias at present.
Global Emerging Markets strategy: sell high-beta currencies, but also low-beta Asian currencies
A hard landing in China would accentuate a bearish bias on Asian FX, with three main categories in mind. One might look to sell Asian currencies, as these tend to be highly leveraged upon global growth expectations. The high-beta Asian currencies would be on the front line, in particular the KRW, the THB, the INR, the PHP or the IDR. But even the low-beta currencies would not be spared under this scenario. This is because the region as a whole would likely be subject to significant capital outflows, which would also affect the SGD, the MYR or the TWD.
Away from Asia, one might also be quite bearish on currencies from commodity exporters, such as the Russian ruble (RUB), the South African rand (ZAR) and most Latin American currencies, including the Chilean peso (CLP). Indeed, favourite non-Asian currencies to short would be the CLP and the ZAR. Finally, SA recommends selling liquidity currencies that have benefited from a risk-on environment. These include the Mexican peso (MXN), the Turkish lira (TRY), the Hungarian forint (HUF) and the Polish zloty (PLN).
Emerging Markets: Central banks maintain a dovish bias
Global Emerging Market central banks continue to maintain a dovish bias, given challenging growth conditions, and they believe that a hard landing in China would trigger an acceleration of the easing policy responses. In some cases, this could also mean a policy reversal, such as in Asia where central banks are on balance back to neutral. In other words, Asian central banks would move back to cutting their policy rates again, but they would also expect policy easing in Latin America, and particularly from the central banks of Mexico, Brazil and Chile.
A slowdown in China would therefore make them initiate front-end receiver positions in Chile and Brazil in particular. While the Brazil central bank has turned quite hawkish, they believe the BCB would not hesitate to cut aggressively in the face of a Chinese slump. The central banks of Mexico and Chile are not in easing mode at present, but they believe they would change gear if China slowed quite aggressively, as these two countries are quite sensitive to external conditions.
In EMEA, their favorite markets in which to initiate front-end receivers would be Israel and the Czech Republic, which present defensive characteristics. Beyond the impact of the China hard landing, one important consideration would be to assess the relative effect of the Fed policy, which for now is pushing for a significant correction in Emerging Markets local rates.