EM markets navigating Russia war, global monetary tightening
Talking Points: US CPI rises above 8% for first time since 1981, yet underlying details suggest this may be the peak
Global: Yesterday, CPI data out of the US showed headline inflation accelerated by more than expected to a new 1981-high of 8.5% y/y in March, yet markets reacted as if this were a weak print. US Treasury yields dropped sharply, while the USD temporarily lost its topside momentum (to the benefit of the ZAR). While initially surprising, this reaction makes sense in hindsight given just how aggressively the market raised its expectations for extreme Fed monetary tightening in recent weeks and how inflation excluding energy and food actually moderated. Furthermore, the market may now be pricing in the latest print as the peak in inflation. Often, when a market is so fully priced in one direction, concern over a potential correction will drive investors to look for a reason to justify it. In this case, signs that core goods inflation in the US potentially peaked were that reason. Goods inflation ex food and energy fell 0.4% m/m, marking its first decline in a year. While this was offset by core services inflation, which rose 0.6% m/m, the market latched onto signs that US inflation may have reached a high-water mark in March. While this would need to be confirmed in upcoming prints, it means that the slow decline from multi-decade high inflation may begin as soon as April.
South Africa: Yesterday, the SARB released its bi-annual review of its monetary policy stance. Predictably, it highlighted the conundrum that the SARB faces in ensuring that inflation remains contained while still supporting growth. The rise in oil and commodity prices remains the main threat to the economy and the SARB's inflation mandate and warrants the SARB hiking rates. However, the SARB was at pains to point out that although it had lifted the repo rate, that monetary policy remained accommodative of growth. However one chooses to interpret this; the underlying message remains that interest rates are set to migrate higher through the year. The SARB aims to contain inflation and match the rate hikes of its major trading partners, lest it inadvertently creates an opportunity for negative speculation against the ZAR that would further exacerbate inflation. The SARB also confirmed that it would be changing money market dynamics. It will transition away from the current system where the central bank estimates the liquidity needs of the banks and engineers a money market shortage to one where banks will be allowed to carry a surplus and park excess funds with the central bank at the prevailing rate. The expectation is that this will improve price discovery in the money markets and move the SARB's policy more in line with global best practices.
Turkey: In a bid to boost the country's reserves, Turkey is planning to increase the rate at which exporters must convert their hard currency revenue into lira to 40%, from 25%. According to Bloomberg, the CBRT Governor Sahap Kavciouglu discussed the plan yesterday with members of the Turkish Exporters Assembly. However, the proposal still requires Treasury and Finance Ministry approval. Turkey's reserves continue to drop, down 7.9% from the end of last year to sit at $67bn. The depletion of reserves is a result of the central bank directly intervening in the FX market to protect the local currency from collapsing. With the monetary authority reluctant to support the local currency through increasing interest rate, state banks and the CBRT have been intervening in the FX market to manage the volatility.
Russia: President Vladimir Putin has said that peace talks with Ukraine hit a dead end, using his first public comments on the conflict in more than a week to vow that his troops would win the war. In the strongest signal to date that the war will grind on for longer, Putin said Kyiv had derailed peace talks by staging fake claims of Russian war crimes and by demanding security guarantees to cover the whole of Ukraine. Russia will "rhythmically and calmly" continue its operation, but the most important strategic conclusion was that the unipolar international order which the US had built after the Cold War was breaking up, Putin added.
Hungary: Hungary was in the EU crosshairs during a regular stocktaking of the rule of law held by EU ministers yesterday. Justice Commissioner Didier Reynders said that Hungarian PM Viktor Orban's landslide victory does not negate his government's duty to uphold EU norms on rule of law, including LGBTQ rights. This statement came after Budapest's Justice Minister, Judith Varga, argued that voters had shown they were not concerned by Brussel's claims of democratic backsliding. With both parties showing that they are not backing away from their positions, the tension between Budapest and Brussels is likely to drag on further. However, the EU will serve Hungary an official letter of the start of the conditionality mechanism procedure at the end of April, a measure that will deprive Budapest of accessing billions of euros.
Poland: Poland's data card picks up today with current and trade balance statistics on tap. The current account deficit narrowed from a more than a seven-year high of -EUR2.49bn in December to -EUR64m in January, its smallest shortfall in eight months. However, this improvement in the external position is unlikely to be sustained in the coming months as the trade dynamics deteriorate due to the fallout between Russia and Ukraine, boosting energy imports. Forecasts compiled by Bloomberg show that the current account deficit widened to EUR2.095bn in February. Should the latest reading match expectations, this could weigh on the local currency as it increases its vulnerability to external shocks.
Czech Republic: Russia's invasion of Ukraine has changed the priorities to be addressed during the upcoming Czech presidency of the European Union in the second half of this year. In a meeting yesterday, Czech Foreign Minister Jan Lipavsky and his Austrian, Slovakian, Slovenian and Hungarian counterparts stated that among the new themes are energy security, expanding EU defence capabilities, refugee support, combating disinformation, and hybrid threats. The foreign ministers discussed holding a donors' conference to help Ukraine in the aftermath of the war. Additional sanctions against Russia were also considered in the event of further escalation in the Ukraine war. Hungary and Austria, however, repeated their opposition to further EU measures targeting Russian energy imports.
Forex: ZAR remains resilient despite local headwinds
South Africa: There is something to be said about the ZAR's recent resilience, especially given all the negative headlines in SA this week. Eskom has re-implemented stage two loadshedding. Floods in KwaZulu-Natal have caused untold damage. Parliament has disappointingly cleared former Health Minister Zweli Mkhize of breaching the ethics code despite acknowledging that his family benefited from the Digital Vibes scandal. Former President Jacob Zuma continues to find ways to avoid his day in court. Yet the ZAR continues to power ahead on the back of elevated commodity prices, strong trade accounts, positive carry, a prudent central bank, and manageable inflation. Further ZAR appreciation towards the March lows of R14.4000/$ is thus possible in the near term, although the market may need a catalyst to break lower from there.
Turkey: The USD-TRY bears remain in control for the second successive session on the back of the stronger than expected factory output growth and falling UST yields as traders tempered rate hike expectations. The pair retreated by about 0.65%, its biggest intraday move in more than two weeks. As a result of the slide, the pair closed the session at the 14.5915 mark. Ahead of the local open, the USD-TRY is trading relatively flat as investors err on the side of caution ahead of the CBRT MPC meeting slated for tomorrow.
Russia: The RUB extended its recent decline against the USD, depreciating 0.80% through the session as the market continued to price in the recent easing of capital controls. Comments by President Putin that suggested Russia was comfortable with a stretched out war in Ukraine likely also didn't help the RUB. Technically, the currency looks comfortable between 77.00/$ and 82.00/$ at present, and will likely continue to consolidate in this range for the time being. Notwithstanding sanction pain, the RUB continues to be supported by export revenues as oil prices remain elevated, while remaining capital controls are also keep it stable.
Hungary: CEE currencies were a mixed bag yesterday, with the HUF and PLN in green while the CZK was in red. The HUF rallied by about 0.24% against the EUR, driven by the speculation that the NBH will continue to hike interest rates amid rising crude oil prices stoking inflation pressure and the falling UST yields. However, the gains in the local currency are limited by concerns over European Union funds as the European Commission launches disciplinary action against Hungary over rule-of-law violations, lingering geopolitical tension and China's lockdown due to rising COVID-19 cases.
Poland: The EUR-PLN pared some of the previous session gains on Tuesday, slipping by about 0.23%. However, the cross remains wedged between the 50-and 100-SMA, signalling that momentum to the downside is not strong. Note the cross has been ebbing and flowing in this range since the start of the new month. Notwithstanding the rangebound trading, the bias in the cross is to the upside on the back of the elevated geopolitical tension. Focus will also be turning to tomorrow's ECB meeting, which has the potential to be fairly market-moving for the common currency.
Czech Republic: Yesterday, the EUR-CZK bulls and bears clashed amid a lack of triggers. The bears failed to dip below the 24.400 level, while the bulls were unable to rise above the 24.500 level. The pair closed the session nearly flat at 24.446. The risk-averse tone that permeates financial markets this morning has resulted in a firmer EUR-CZK ahead of the European Open. Later in the session, the current account data will most likely support the pair. A break above 24.500 would provide support to a more bullish bias.
Fixed Income: EM bond markets enjoy temporary reprieve from falling UST yields
South Africa: As GDP growth forecasts are revised slightly higher, and inflation remains under control, and within the target range, the risk to what the market has priced in is that investors are positioned for too many hikes. The curve steepened slightly through the past week, in sympathy with the slight steepening in the US curve. SA's bond market looks set to weather the storm better than most, and the SARB's typically conservative stance has offered SA some reward. The spread between the R213 and the R186 has lifted to 1.805% and reflects a more balanced perspective of the economy.
Turkey: Turkish local-currency bonds attracted some strong demand yesterday, with yields tracking US Treasury yields lower through the session. Moves were especially pronounced at the short-end of the curve, where the 2-year bond led the charge with a 100bps decline on the day. This move also added impetus to a market that has been relatively flat over the last two weeks (on aggregate), although it remains to be seen whether it can be sustained given that UST yields are once again on the rise.
Russia: Russian bonds generally declined on Tuesday, adding to a broader trend seen through April. The yield curve has bull-steepened through the month as investors have positioned for fewer CBR rate hikes after initial uncertainty over the war. Pulling the lens back further, however, the impact of the war on Russia's bond market is severe. Yields have increased by over 525bps for some tenors at the short-end of the curve, while the long-end has risen by around 250bps on average. This weakness is expected to be sustained over the medium term, especially since there are no signs of the war ending anytime soon.
Hungary: Hungarian bonds took a breather yesterday after yields dipped across the curve for the first time in six sessions. The yield curve shifted lower on the back of falling UST yields as rate traders tempered their inflation bets for upcoming FOMC meetings and a stronger HUF. A more pronounced fall was seen at the long end of the curve, with the 10yr HGB yield down more than 11bps. While the 5yr tenor's yield drifted lower by more than 7bps, and the 2yr yield was a little changed. As a result, the 10v2 spread remained deeply inverted, sitting at a negative 33bps.
Poland: The appetite for Polish bonds improved during a regular auction held yesterday. At the open auction, the Polish government sold PLN4.0bn in five types of T-bonds after demand arrived at PLN5.77bn, matching the upper-end of the PLN1 - 4bn supply range. Interest was most notable for the 2027 bond, attracting demand of PLN2.86bn, prompting the government to sell PLN1.75bn, generating a cover ratio of 1.64. Investors also preferred the 2032 bond, with primary dealers bidding for PLN1.95bn and the finance ministry selling PLN1.56bn. Poland then sold PLN540m of the 2032 and PLN43m of 2027 fixed-rate bonds at the top-up auction. Clearing yields increased yesterday. The 2027 bond was cleared at 6.87%, up from 5.57% on March 24, and 2032 cleared at 6.26% versus 5.22%. The increase in clearing yields could have underpinned the improvement in demand for local debt.
Czech Republic: A modest receiver bias was recorded along the IRS curve yesterday, with swap rates on the short-end and the belly of the curve falling by 5bps to 10bps. This comes on the heels of yesterday's US inflation report, which showed that core inflation was modestly lower than expected, easing worries of runaway inflation. Still, the market is pricing in further rate hikes this year, and swap rates will fall sharply until all the rate hike risk is undone. Receiving positions would become more appealing as a result of this. 
