EMTA Summer Forum in London;
Investors Generally More Optimistic About Rate Outlook
Merrill
Lynch hosted EMTA’s Summer Forum in London on Monday, June 21, 2004. A
standing-room only crowd of over 200 EM professionals attended two panel
discussions covering such topics as US interest rates, market leverage, and
specific Emerging Markets economies such as Argentina, Brazil, Turkey and
Russia.
EMTA Co-Chair Mark Coombs (Ashmore) opened the meeting by reviewing EMTA’s mission to promote the Emerging Markets asset class. He reminded the audience that EMTA continued to encourage active market participation on how best to advocate industry positions with the public sector and regulatory bodies.
Jerome Booth (Ashmore) moderated the investor panel and informed spectators he would focus more than in the past on the "bigger picture," reasoning that external factors might have more impact on EM economies than any individual domestic catalyst.
Arnab Das (Dresdner Kleinwort Benson) agreed that the predominant factors facing the Emerging Markets today were US interest rate policy and, to a lesser extent, the impact of a slowing Chinese economy on commodity pricing. Das noted that Dresdner’s house view on rates was relatively bullish, with a forecast of only four 25 bp rate hikes in 2004 and no further action next year. "Although we might get some credit events—some small countries or some corporates—but the major countries and the market in general will survive—not unscathed but without too much difficulty—during this tightening," he predicted.
Other analyst forecasts of the Fed tightening cycle were more cautious. Joyce Chang (JP Morgan) countered that her firm was forecasting a Fed tightening of 125 bps in 2004 and a further 200 bps in 2005. "We see this as a bear market rally for fixed income; we would not get carried away with the improving risk appetite trend and we choose to play Emerging Markets from an underweight perspective," Ms. Chang asserted. Ms. Chang also warned that after three years of loose monetary policy, there could be "room for accidents." She informed attendees that, according to internal analysis, hedge funds accounted for 40% of client flows in two months preceding the Forum (vs. 20% in January), which could indicate that a good deal of leverage had already been unwound, although she expressed concern that there could still be a significant amount of deleveraging to take place.
UBS’ Alex Garrard noted that the UBS house view was closer to JP Morgan’s than to Dresdner’s, with forecasts of 100 bp and 200 bp hikes for 2004 and 2005, respectively. He added that the technical picture was relatively benign in light of the significant amount of deleveraging which appears to have already taken place.
According to Larry Brainard of WestLB, there is a "great deal of anxiety" in the market due to the contrast between positive economic numbers and prospects for EM countries on the one hand; and "unsustainable fiscal policies and excessively stimulative monetary policies" in G-7 countries, an unsustainable US current account deficit, and a number of "asset price bubbles" on the other. When these factors will hit emerging economies is the essential challenge for all EM investors, he reasoned.
Booth asked if panelists agreed with him that inflation was not really a serious threat; and if so, why were they not more bullish on the EM debt asset class Ms. Chang responded that current inflation numbers were "not disastrous," but that a slight underweight in the asset class was justified because of possible volatility in light of her firm’s forecast of 325 bps in Fed rate hikes over the next 18 months, and de-synchronized global tightening.
The analysts were also polled for their recommendations on what policy reforms could be completed in Brazil. Das opined that the best solution would be social security system reforms that would bring liabilities in line with its capacity to pay over the long run, while acknowledging that because of political issues, "that obviously is not going to happen overnight." Brainard cited "long overdue" tax reforms and the need to open the Brazilian markets to imports.
Booth next asked the speakers to explain why Turkish debt spreads were so much tighter than those on Brazilian issues. Garrard replied that Turkey’s track record of growth justified the spread differential. He added that because of prospects for EU accession, analysts might soon be making a comparison between Turkish spreads and those of Bulgarian debt, rather than between Turkish and Brazilian spreads. Das reasoned that Turkey’s lower spreads were justified by eventual EU membership, and its tighter relationship with the US.
Finally, Ms. Chang attributed the difference to the differing vulnerability to foreign investor appetite vs. domestic investor appetite. Local banks hold 80% of Turkey’s external debt and the country can rely on its local market to absorb new issuance, Ms. Chang argued, while Brazil needs to develop deeper domestic markets.
The panel discussion also included a debate on China. Ms. Chang characterized the economy as "hot but not overheating…it’s too early to write off the possibility of a hard landing, but that is not our core scenario."
As for Russia, Brainard expressed a dissident view that Russian progress on structural reforms was "not very impressive…or encouraging."
Investors Discuss Fed
Tightening, Brazil, etc.
Tulio
Vera (Merrill Lynch) apologized in advance for beginning the Investor Panel by
returning to a discussion of the global economic background, but asserted that
since it was the "key driver" for the Emerging Markets, he thought
investor opinions would also be of great interest to attendees. Vera polled
investor panelists for their expectations of the Fed tightening cycle, and in
general investors expected a less dramatic tightening cycle than their sell-side
counterparts.
BlueBay Asset Management’s Simon Treacher shrugged off suggestions that the US FOMC was "behind the curve." He predicted that for the next four quarters the Fed would increase rates by 25 bps and that would prove sufficient.
Michael Sonner of DIT believed that the market had already discounted 75-100 bps over the next six months. "I still think the asset class will not derail [due to Fed hikes], but the spread widening will be fairly insignificant," he concluded.
In contrast, DWS’ Christian Kopf opined that there would likely need to be monetary tightening in excess of 100 bps in 2004, but also forecast additional increases in 2005. Finally, John Cleary (Standard Asset Management) offered his assessment that he was less concerned with the amount of the interest rate increase than the volatility induced by it. Over the longer term, "the quicker that interest rate hikes happen, and the more aggressive they are, the better it is for the asset class as this allows the market to price more accurately, or more favorably, the consequences of that interest rate rise," he asserted.
The amount of leverage in the markets did not alarm any of the investor panelists. Treacher and Sonner concurred that leverage in the markets was "cyclical" and "part of the system." Cleary specified that "the banks are acting as better gate keepers than they have done before, the leverage they have extended to an individual client is less."
Kopf observed, "I get the impression that a lot of formerly long-only asset managers are setting up hedge funds…and this is positive for liquidity." He continued, "Systemic risk of an LTCM-type incident has clearly diminished because the assets are spread over a great variety of different hedge funds and not just one or two really big players." He did acknowledge, however, that a problem could arise if hedge funds have their assets concentrated in the same country or regions.
Vera invited speakers to debate whether the situation in Brazil had really improved enough to weather an external debacle or whether any progress was illusory. Cleary opined "Unfortunately, I don’t think Brazil is shielded," and added that despite improving economic fundamentals, ownership of Brazilian debt is more short-term oriented and it would feel the effects of external events and greater risk aversion.
Kopf agreed that economic fundamentals have not really improved dramatically, although he argued that the country is entering the Fed tightening cycle in the much better position of a huge trade surplus, which he labeled "a big change." Despite the government’s efforts, interest payments as a % of GDP have risen to 9% from 1% five years ago, Kopf stated, and "that’s a lot for a country like Brazil." He added, "They have a debt overhang in a certain way–that doesn’t mean they have to default right now, and I don’t think they will because cyclically they are in a good situation, but one or two years down the road they might have a problem."
Sonner highlighted Brazil’s efforts to "do the right things" for the IMF and the market, "but is it really shielded from a big financial storm, I don’t think so." But would he give them the benefit of the doubt? "I would give Brazil the benefit of the doubt...they have a good chance."
The discussion concluded with commentary on Andean countries, mostly centering on Venezuela. Treacher asserted that President Chavez’s willingness to service external debt was "without a doubt" and argued that Venezuela would be relatively insulated from aggressive US rate hikes. He also forecast Venezuela would carry out additional debt management exercises in the next year.
Kopf and Sonner both saw President Chavez’s remaining in power as the lesser of two evils. Kopf disagreed with Treacher’s complete faith in Venezuelan debt servicing, warning that external bondholders could eventually become a Chavez target.