EMTA Winter Forum (London) - Feb. 16

Attendance is complimentary for EMTA Members / US$695 for non-members.

This Event is SOLD OUT. Please contact Evelyn Ramirez (eramirez@emta.org) to be placed on a waiting list.

Chinese Slowdown, Slower U.S. Growth Among Concerns at EMTA Winter Forum in London

For the twelfth consecutive year, J.P. Morgan hosted EMTA’s Winter Forum in London on Tuesday, February 16, 2016. The event attracted its highest audience ever, with a standing-room only crowd of 200 EM market participants, and was once again held at the historic Great Hall at 60 Victoria Embankment.

Luis Oganes of J.P. Morgan returned as the event moderator. Oganes initiated the session by reviewing recent market conditions, and displayed a slide of predictions for key economic variables provided by his sell side panelists. Speakers were first asked to discuss the global economic environment.

Kasper Bartholdy of Credit Suisse (and an EMTA Board Director) suggested that much of the recent risk market weakness reflected slowing US growth. Bartholdy noted that Credit Suisse’s US economists saw the slowdown as temporary and thought the Fed would still implement two rate hikes in 2016, starting in September.

UBS’ Bhanu Baweja seconded Bartholdy’s call for a total of 50 bps in US rate hikes in 2016. In addition, Baweja argued that the market was using the wrong prism for FX. “Weakness in EM currencies should be viewed as an EM sell-off for EM-specific reasons, not because of dollar strength,” he emphasized.

Luiz Gustavo Cherman (Itau) predicted 2% US GDP growth this year, and specified his base case that improved US consumption would justify three US rate hikes. At the same time, Cherman acknowledged that the risks of disappointment with the US economy were increasing. Itau’s oil call of $55 by the end of 2016 was relatively bullish compared to other panelists, and, based on expectations that US oil production would slow, would bolster prices.

A more bearish view of the global economy was also provided. “I’m not convinced about the durability of US growth,” warned Nomura’s Tim Ash, who detailed a list of risks, including the Chinese slowdown, US elections, global geopolitical issues and concerns about the banking industry.

Ash deemed it unlikely that the Fed would take any action in 2016, and also expected the ECB to keep policy loose for longer because worries over political challenges facing the continent (such as the migrant issue), which would push the ECB to foster high levels of job creation. Ash also placed himself among the oil bears, arguing that Riyadh would keep oil “lower for longer in order to get the US to reengage in the Middle East…get used to $30 oil.”

Ash was equally concerned about China. “It would be extraordinary if China avoids a hard landing…over the next 12 to 18 months,” and he suggested that Beijing’s leaders might not even have a complete grasp of their complicated economy, as it was possible that not every participant in the chain of the centralized economy was necessarily providing all the correct information.

The J.P. Morgan view on the US economy, noted moderator Oganes, was for rate hikes to commence in June. Oil would rise to $40 per barrel with “supply/demand dynamics starting to stabilize, but with risks still to the downside.” Finally, Oganes expected continued weakness in EM currencies.

Oganes invited thoughts on specific markets, starting with Brazil. The BRL was “getting close to equilibrium” in Cherman’s view, although an expected primary deficit of as much as 1.5% of GDP would add pressure to the currency. Cherman forecast the currency at 4.5 BRL/USD at year-end (firmly in the middle of panel estimates, which ranged from 4.2 to 4.7 per dollar). Itau also maintained an out-of-consensus call that the COPOM would cut rates by 2H (to 12.75%), as increasing unemployment would lead to lower inflation.

On Russia, “there is no chance that sanctions will be lifted this year,” declared Ash; for owners of Russian debt, this was positive, with the lack of new issuance providing technical support for existing debt. Despite such technical factors, “Russia is a long-term ‘sell,’ with no growth and no reform,” he concluded.

Speaker views differed on Turkey, while pessimism on South Africa was wide-spread. Turkey deserved an investment grade rating, Ash argued. “It’s a fundamentally sound economy, with a pro-business culture,” although he acknowledged political concerns, both domestic and those resulting from its “difficult neighborhood.” In contrast, Baweja’s outlook on Turkey was decidedly more negative, and further downgrades of Turkey were justifiable. United in their bearish assessment of South Africa, Baweja predicted further downgrades, and Ash questioned whether President Zuma had any vision for the country.

The panel also concurred in two Middle East topics. Speakers agreed that despite market chatter, the Saudi peg would hold. Panelists also shared the view that the Saudi-Russian accord to freeze oil production at January levels would prove meaningless.

Finally, speakers debated whether the unexpected outperformance of EM local debt vis-à-vis other asset classes was sustainable. Bartholdy viewed it as a short-term trade, with Oganes also unwilling to bet on it as likely to continue.

Aberdeen Asset Management’s Kevin Daly led the event’s investor panel. Daly requested investor views on the EM marketplace, asking if market bearishness was justified. Rob Drijkoningnen (Neuberger Berman) responded with relative optimism for the EM asset class, stating that his firm’s base case was that the US and EU economies would perform well enough to provide a stable background. Graham Stock (Blue Bay Asset Management) argued that the main global risks--a Chinese hard landing, a decline in US growth and low oil pricing-- were “individually overplayed...but the combination of these factors could be disastrous.”

Ben Sarano (EMSO) believed that oil pricing could remain vulnerable to further declines near-term, but was likely to be near its nadir. He added that much wider spreads were possible for EM debt generally in the market malaise. Greg Saichin (Allianz Global Investors) identified oil as the single most important factor driving EM spreads, highlighting the strong recent correlation. However, Saichin suggested that concerns for the asset class were overdone, and criticized ratings agencies for “accelerating the pace of downgrades inappropriately.”

Daly prompted a specific dialogue on oil price forecasts for 2016. Stock expected a range of $25 to $40 per barrel, with prices trending higher in the 2H. Riyadh’s goal was to “destroy non-Saudi production” and would play the long –game; he added that the deal between Saudi Arabia and other nations, which offered Saudi production cuts if other exporters did likewise, was “meaningless, as we all know Iran won’t follow suit.” Stock saw a gradual rise in price momentum as global demand inched up in the 2H, and mature wells offering less supply as they became less productive. He offered a prediction of oil at $50 by 2019/2020.

Sarano agreed that, “the seeds of higher oil prices have been sewn...but pricing will be much more volatile than in the past.” Increased price volatility could in itself lead to reduced financing of new ventures, thus depressing supply. Drijkoningen forecast an average price of $36 per barrel in 2016, and ventured that, “EM energy issuers have the advantage of depreciated currencies, reducing default risk meaningfully compared to their US counterparts.”

Daly also followed up on market concerns on China, asking if recent comments from Beijing on the CNY exchange rate would suffice to calm the market. Saichin considered a CNY fx regime change not much more than a tail risk, and would be enacted only as “a measure of last resort.” On the other hand, the Chinese economy remained overall a big risk because of its importance in global demand, he underscored. Drijkoningen noted that a Chinese devaluation would clearly result in competitive devaluations by other Asian countries, and specified that a major change in the CNY fx rate as unlikely, “given the Chinese government’s preference for going slow.” The potential for structural reforms in the Chinese economy could restore some degree of market confidence, and could shift investor focus to the potential upside rather than downside, in his view.

Turning to Brazil, Stock saw real assets in Brazil as cheap, following the dramatic decline of the BRL. “I’m hearing of investors looking at opportunities in real estate and private equity, which we know are usually longer-term investments,” and pondered if it were time to make bets on the new administration which will come into power following the 2018 elections. Brazilian inflation was near its peak, and rate cuts were possible in the 2H. Stock highlighted that Petrobras continued to face challenges despite possible official support, citing efficiency issues in addition to weak oil pricing.

“Brazil has lost virtually all its anchors,” declared Sarano, observing that investor confidence in the Central Bank has dropped, the chance of a primary surplus was “non-existent, and the overall budget deficit is getting to a fairly worrying level.” The BRL was not safe from significant further weakening, and could take spreads with it. “The only positive factor is that Brazil has very little external debt, and most of it is long-term,” he said. Petrobras, on the other hand, was sort of an orphan credit, with “no natural buyers” due to factors not limited to its omission from widely-used indices. “The bonds are already pricing in more chance of default than is likely...and it is far too cheap compared to the sovereign,” he concluded.

Focus was also given to the high beta credits. There remained further upside potential for Argentina, according to Saichin, who pointed out that Argentina was soon to return to the mainstream EM market after a long banishment to “frontier” status. “It’s one of the few countries that now offer expectations.” Addressing concern of an oversupply of debt resulting from an eventual deal, Saichin voiced optimism that such debt would find its way to holders.

On Venezuela, “2016 could finally be the year they default...but that is clearly reflected in the price,” argued Sarano. As the Bolivarian Republic faced no major principal maturities until 2018, one possible scenario was for PDVSA to default, while the sovereign struggled successfully to pay coupons. Sarano opined that a sovereign default would likely lead to a (market-positive) regime change, although it could also open up a Pandora’s box of additional indebtedness issues of which the market was not yet aware. Drijkoningen concurred that the likelihood of a Venezuelan default was “very high,” while assessing that a PDVSA-only default was unlikely as “they are the ones with the external assets.” Stock anticipated an eventual Venezuelan restructuring would include “lots of oil warrants...but in practice that is what you really hold now, if you own Venezuela.”

As for Ukraine, Sarano acknowledged that his firm maintained a flat position “for the first time in a long time.” He judged debt prices as reasonable with upside potential under a new government, although he referred to the medium-term outlook as “dire.” Drijkoningen was more optimistic. “They could be the new Poland if they can tackle the corruption challenge and pass reforms.”

Finally, Daly steered the panel to a discussion of African credits. Ghana and Zambia were among those recent new issuers who had “had it too easy...there is now a reality check and they will have to work hard to preserve market access,” in Stock’s assessment. Stock also emphasized a near-term credit event for either sovereign was unlikely. In concurrence, Daly added that election year excess was unlikely to occur in Ghana this year, and that the government would maintain fiscal discipline under the IMF program. Saichin included Kenya and Ethiopia among his top recommendations for investment.