BarCap July8 the Emerging Markets Weekly Sunshine Behind the Clouds

8/6/2019 BarCap July8 the Emerging Markets Weekly Sunshine Behind the Clouds

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EMERGING MARKETS RESEARCH 7 July 20

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 34

THE EMERGING MARKETS WEEKLY

Sunshine behind the clouds

Investor confidence in EM suggests that summer price dips are likely to be bought

into. Recent events and volatility in Europe and the US are likely to produce

discounted prices in EM, and we think investors should look to go long, albeit

cautiously. There is sunshine behind the clouds, and we are waiting for a breeze to

blow them away.

Macro Outlooks

Emerging Asia: Inflation headaches 6

The PBoC raised benchmark rates for the third time this year, as inflation remainselevated. Inflation concerns are likely to persist in Emerging Asia, with core price pressures

increasing and persistent.

EEMEA: Doves rule as inflation peaks and growth slows 8

Moderating global commodity prices and prospects for good local harvests, combined

with slowing growth and greater risks of a harder landing globally, seem to have lent

support to more dovish attitudes at central banks across the region.

Latin America: At war again? Yes, but not for long 10

As commodity price pressures dissipate and headline inflation moves south, the

crusade against currency appreciation is starting to re-emerge in the Latin region.

Emerging Markets Corporate Credit: Top of the range warrants cautious longs 12We recommended taking profits on shorts during what we believed was going to be a

volatile June. Spreads are wider now, having priced in further peripheral European

turmoil and ongoing weak US data.

Strategy Focus

Thailand: A tactical long 15

The Puea Thai party election win paves the way for Yingluck Shinawatra to become the

new PM. While we view the result as constructive in the near term, as it reduces

uncertainty, we do not believe it resolves the longer-term issues in Thai politics. But in the

short term, we expect the markets focus to switch back to the economy.

China rates: 1y deposit rate to act as a floor for 7d fixing; curve to remain flat 17

We expect the curve to remain flat in the near term on tight systemic liquidity. The 1y

deposit rate will serve as a floor for money market rates in a tight liquidity environment.

EM sovereign credit: Beta-driven shifts in positioning 19

A comparison of Barclays Capital EM sovereign Overweight/Underweight views with

market positioning as of end-May reveals some interesting insights. We recommend

adding exposure to Philippines versus Indonesia and, driven by the recent developments

with President Chavez, suggest adding risk to Venezuela. For all three credits, defensive

positioning should constitute an important anchor over the next few weeks.

EM Views on a Page

EM Dashboard

EM FX Views on a Page

EM Credit Portfolio

Data Review & Preview

FX Forecasts and Forwards

Official Interest Rates

What we like

Local Bonds Buy long-dated MGS

FX Short EUR/RON via 6m T-bills

Credit Add convexity exposure at theend of the PDVSA curve (PD 2

Weekly EM Asset Performance

EM FX

-0.1%

0.2%

0.3%

0.6%

1.2

1

-0.3%

0.6%

TWD/USD

RUB/USD

TRY/USD

KRW/USD

BRL/USD

INR/USD

CLP/USD

MXN/USD

ZAR/USD

EM Rates

-9 bp-7 bp

-5 bp

-3 bp

3 b

4 4

3 b

-15 bpIndo 5yr GovHun 5yr IRSCZK 5yr IRS

SA 2yr IRS

Pol 5yr IRSBraz Jan 12

India 2yr IRS

Mex TIIE 5yrKor 2yr IRS

CLP 2yr IRS

EM Credit

-23 bp-9 bp

-7 bp-5 bp

-5 bp-5 bp

0

-28 bpArg 5yr CDS

Veni 5yr CDSIndo 5yr CDS

Phils 5yrMex 5yr CDS

Braz 5yr CDSRus 5yr CDS

SA 5yr CDSTurk 5yr CDS

Hun 5yr CDS

EM Equ0.6%

1.2%1.2%

1.3%1.3%1.4%

2.4%

3

0.3%

3

BolsaBovespa

ShanghaiSensex

Turkey ISEFTSE JSE

JSE All share

S&PRussia RTS

Kospi

Note: EM Assets Performance charts as of 07July 2011 excespreads, which are as of 06 July 2011.Source: Bloomberg, Markit, Barclays Capital


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Barclays Capital | The Emerging Markets Weekly

7 July 2011 2

EM VIEWS ON A PAGE

What happened

Markets The risk-rally continued from last week, with positive news flow from the US in the form of a better-than-expected ADP employmentreport and ISM manufacturing report. The EUR slid against the USD on concerns over Portugal and Peripheral Europe. EM FXappreciated. EM credit was modestly tighter, particularly Venezuela, after President Hugo Chavez confirmed that he has been

diagnosed with cancer and is undergoing treatment. Fitch upgraded Romania from BB+ to BBB-, putting the credit back to investmentgrade as Moodys already rates the credit Baa3.

Globalmacro

The ECB increased the repo rate 25bp to 1.50% today and signalled that rates may rise again in the coming months. Moodysdowngraded Portugals sovereign credit rating four notches to Ba2 from Baa1, putting it at junk status. The current opposition party inThailand, Puea Thai, which is linked to ex-PM Thaksin Shinawatra, won elections on July 3 by a simple majority.

Monetary policy

PBoC raised its deposit/lending rates by 25bp effective July 7. This is the third rise in benchmark interest rates this year, bringing the one-year lending rate to 6.56%. Malaysia left its policy rate on hold at 3.0%, contrary to our and market expectations for a 25bp hike. Polandkept its policy rate unchanged at 4.5% as expected by us and consensus.

What we think

EMassets

Investor confidence in EM suggests that summer price dips are likely to be bought into. Recent events and volatility in Europe and theUS are likely to produce discounted prices in EM, and we think investors should look to go long, albeit cautiously. We believe there issunshine behind the clouds, and we are waiting for a breeze to move them away.

What we like

Asset

class Trade Rationale

LocalBonds

Buy long-datedMGS

News about the divestment programme has started to improve in Malaysia, and we expect proceeds from thegovernments asset sales to help to reduce the fiscal deficit to 4.3% of GDP.

FX Short EUR/RONvia 6m T-bills

The demand for FX from local Greek bank subsidiaries in Romania remains the main risk for the currency butEUR/RON has managed to stabilize below 4.25, suggesting that investor positioning is now significantly lighter.Moreover, the recent endorsement by the IMF and Fitch of Romania's improving fundamentals, in our view,further supports the appealing RON catch-up potential relative to other CEE currency peers.

Credit Add convexityexposure at thelong end of thePDVSA curve (PD27, 37s)

Chavez health issues represent a challenge for the government ahead of the presidential election, as the illnesswill likely limit his ability to address his declining popularity. Also, any possible successors will be at adisadvantage with respect to the main opposition leaders, who have shown more solid leadership. The possibilityof a democratic transition may continue to increase, providing additional support to Venezuelan assets. Againstthis background, we look to add convexity exposure at the long end of the curve.

Figure 1: Recent rally in risky assets has been impressive

Figure 2: PD 17Ns still our top pick, however convexity of PD

27/37s may spur outperformance if momentum continues

2,400

2,500

2,600

2,700

2,800

2,900

3,000

Nov-10 Jan-11 Mar-11 May-11 Jul-11

Nasdaq

PD14

PD15

PD16

PD17N

PD17

PD22

PD27 PD37

1,050

1,100

1,150

1,200

1,250

1,300

1,350

1,400

0 5 10 15 20 25 30

Average Life

Recover Ad usted S read b

Source: Bloomberg Source: Bloomberg


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7 July 2011 3

EMERGING MARKETS OUTLOOK

Sunshine behind the clouds

Investor confidence in EM suggests that summer price dips are likely to be bought into.

Recent events and volatility in Europe and the US are likely to produce discounted pricesin EM, and we think investors should look to go long, albeit cautiously. There is sunshine

behind the clouds, and we are waiting for a breeze to blow them away.

What happened?

In Europe: The approval of the Greek austerity plan and its implementation law, which

included a privatisation package, boosted market sentiment last week. However, on

Wednesday, Moodys disturbed the seemingly calm waters by downgrading Portugals long-

term government bond ratings to Ba2, or junk, from Baa1. This move put Ireland back on

the radar as well, with some market participants now expecting a downgrade of its rating.

Newswires reported that Germany may revive a proposal that involves a voluntary exchange

of debt for bonds with a longer maturity. Markets are likely to be watchful until further

clarity materialises.

In the US: Approval of the Greek austerity plan coincided with the end of QE2 and stronger-

than-expected US data, and resulted in US 10y yields moving higher. Recent Treasury

auction results indicate weaker demand for the 2y, 5y and 7y tenors. Our US economists

view the increase in yields as a reflection of increased risk appetite and better economic

data rather than the end of QE2. The drop in yields after Portugals downgrade could be

seen as supporting our economists view.

In China: On Wednesday, the PBoC announced the third benchmark interest rate hike in 2011,

the fifth hike in the current tightening cycle, which began in October 2010. The increase was

in line with expectations, and we do not rule out the possibility of one more rate hike in Q3 11.

In EM: Financial assets have performed relatively well in the past month, with only EM

equities clearly underperforming advanced economies. EM FX remained resilient, moving in

line with the DXY. EM credit significantly outperformed in June, with the BarCap sovereign

and corporate USD credit indices returning +1.2% and -0.6%, respectively, compared with -

Kumar Rachapudi

+65 6308 [email protected]

Ju Wang

+65 6308 2801

[email protected]

Nick Verdi

+65 6308 3093

[email protected]

Figure 1: EM bonds outperformed despite sell-off in USTs Figure 2: buoyed by FX returns

98.0

98.5

99.0

99.5

100.0

100.5

101.0

101.5

1-Jun 11-Jun 21-Jun 1-Jul

2.8

2.9

2.9

3.0

3.0

3.1

3.1

3.2

3.2

3.3Barcap EM LCY Bond IndexBarcap EM Asia LCY Bond Index10y UST (%, RHS)

99.8

99.8

99.9

99.9

100.0

100.0

100.1

100.1

100.2

100.2

100.3

1-Jun 11-Jun 21-Jun 1-Jul

2.85

2.90

2.95

3.00

3.05

3.10

3.15

3.20

10y UST (%, RHS)Barcap EM Asia LCY Bond Index (FX hedged)Barcap EM LCY Bond Index (FX hedged)

Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital


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7 July 2011 4

0.9% and -1.0% for US IG and HY (total returns). In local markets, FX-hedged bond

portfolios were stable during the risk-off period and gained significantly even as USTs sold

off in the last week of June. However, this outperformance is largely a result of the buffer

provided by EM FX, especially in Asia.

What we think?

EM assets seem to have become something of a safe haven. Along with stronger growth

fundamentals, we believe the near-term outlook for EM is positive compared with

developed markets. Investors seem to agree, as shown by inflows to the asset class.

Although we do not recommend taking on significant directional risk in EM at the moment,

given current valuations, the apparent investor confidence in various EM market segments

suggests that during a potentially noisy summer, price dips are likely to be bought into.

Moreover, once the summer storms have passed, EM assets, especially currencies and

sovereign credit, look poised to do well. The current volatility in Europe and the US will likely

create discounts on some of these assets. Barring an increase in systemic risk aversion, we

think investors should use these opportunities to go long.

That said, investors need to be mindful of risks. The situation in Europe, assuming it does

not worsen, is likely to result in EM assets trading sideways, in our view. However, any

sustained deterioration in peripheral Euro zone debt markets could lead to some pressures

in wholesale funding markets, particularly if investors nervousness about European bank

balance sheets increases. In fact, Portugals four-notch downgrade has already unsettled

market confidence. This is particularly important as the Fed is no longer supplying dollars

via QE2. However, the extension of the Feds swap lines with various foreign central banks

through August 2012 should serve as a backstop against these pressures. In any case, any

potential stress in funding will result in a bid for the USD. This channel of global liquidity

could mean tighter conditions for EM, and result in EM FX underperforming, which, in turn,

could see EM bonds weakening, especially where foreign participation is high.

A sell-off in US Treasuries, either because of heightened debt ceiling concerns or because of

better-than-expected data, is a risk to watch. The latter would likely be positive for risk, and

both EM equities and FX are likely to outperform. Even if this results in higher UST yields, EM

bond portfolios are likely to do well, especially after taking into account the buffer provided

by expected FX gains. However, heightened concerns about a US debt ceiling agreement

would likely result in increased risk aversion and steeper rate curves.

What we like?

Given the current risk sentiment, we prefer either countries with strong idiosyncratic

dynamics or low beta trades.

In EM FX, as a low-beta trade, we recommend going long the SGD against a basket of the

USD (60%) and EUR (40%). In EEMEA, we recommend longs in ILS (a low beta currency

with the backstop of a C/A surplus) and RON. The demand for FX from local Greek bank

subsidiaries in Romania remains the main risk for the currency but EUR/RON has managed

to stabilise below 4.25, suggesting that investor positioning is now significantly lighter.

Moreover, the recent endorsement by the IMF and Fitch of Romania's improving

fundamentals, in our view, further supports the appealing RON catch-up potential relative

to other CEE currency peers.

EM assets have become

something of a safe haven and

we recommend buying into any

price dips

However, risks remain.

Further deterioration in

peripheral Europe would imply a

need to monitor potential

funding concerns

A sell-off in USTs because of

better-than-expected data is

likely to be positive for risk

assets. However, sell-offs due to

debt ceiling concerns would

likely result in risk aversion

We recommend going long SGD

(vs a basket of USD and EUR)

and ILS as low beta trades


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7 July 2011 5

In rates, we recommend paying the front-end and positioning for curve flattening. Ahead of

the RBI policy review on 26 July, India 1y remains a pay, in our view. Loan-to-deposit ratios

in HKD-denominated lending are rising, which has likely driven the Hibor underperformance

versus Libor in recent months. Although we do not expect an imminent funding squeeze in

Hong Kong, we recommend hedging that risk via a low-beta spread trade. We suggestpaying 5y HK rates and receiving 0.88x DV01 in US 5y. In general, we continue to

recommend owning long-end bonds across Asia and, in particular, we highlight Malaysiathis week. News about the divestment programme has started to improve in Malaysia, and

we expect proceeds from the governments asset sales to help to reduce the fiscal deficit to

4.3% of GDP (the governments forecast is 5.4% of GDP). We recommend owning long-end

Malaysian government bonds.

We see room in EEMEA rates for some good RV trades right now and one we especially

favour is paying PLN 5y/5y against EUR in swaps. This is different from our global rates

theme but is still ultimately a defensive trade that suits the current environment: a

continuing soft patch in European cyclical data should pull down back-end yields in

Europe but PLN yields will probably underperform as the latter has become reliant on

foreign capital inflows that could dry up. There are some leverage challenges in Poland

as well that, we think, will probably prevent back-end yields from rallying as much asEUR yields.

In credit we highlight Romania's upgrade back to investment grade this week, which

contrasts with the downgrades in Western Europe and is a further reminder of the diverging

paths of CEE and the Western European periphery. Against the backdrop of medium-term

uncertainties around the 2012 elections and the developments in Greece/Greek banks, we

view the regained IG status as supportive of Romania credit and we recommend adding

exposure to Romania's EUR-denominated bonds (EUR 16s, 18s), potentially as a switch

from the expensive Croatia EUR 14s. Recent positioning data (see Focus piece) suggests

that investors are very defensively positioned in Turkey cash credit. Given Turkey's solid

longer-term credit profile and the flatness of the spread curve, we continue to think that the

5y sector (Turkey 16s, 17s) offers value at current levels.

Pay 1y India OIS, and buy long-

dated MGS in Asia

And in EEMEA, we like paying

PLN 5y5y against EUR as a

defensive trade

We like switching out of

Croatias EUR denominated

bonds in to Romania...

and think Turkey 16s, 17s

offer value at current levels


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7 July 2011 6

MACRO OUTLOOK: EMERGING ASIA

Inflation headaches

The PBoC raised benchmark rates for the third time this year, as inflation remainselevated.

Inflation concerns are likely to persist in Emerging Asia, with core price pressuresincreasing and persistent.

Next week, Chinese data are expected to show slower growth and sticky inflation. Wealso have monetary policy meetings in Korea, Thailand and Indonesia.

China: Another rate hike points to restrictive monetary conditions

On Wednesday, the PBoC announced the third benchmark interest rate hike of 2011. This is

the fifth increase in the current tightening cycle, which began in October 2010. The

structure of the hike is symmetrical a 25bp increase in the ending and deposit rates across

all tenors, except the demand deposit rate, which was left unchanged. While we have been

calling for the third rate hike in early to mid-July in the past month, the June rate pause

(versus a widely expected hike) suggested to us increasing domestic concerns about "policy

over-tightening", a view that has been widely debated in the last month.

The June RRR hike, which resulted in a surge in interbank rates and liquidity

hoarding/shortage, in our view, has helped bring some consensus that price-based tools,

i.e. interest rates, should be utlised. Also, given likely 6%-plus June CPI (BarCap: 6.3%), we

believe that the PBoC will remain vigilant and will prefer to use interest rates rather than RRR

hikes to tighten policy, if needed. In the PBoC monetary policy committee Q2 meeting

minutes, they adjusted the wording on the operational focus to "Stability, targeted and

flexibility" in Q2 from "targeted, flexibility, and effectiveness" as in the Q1 11 and Q4 10

minutes, and added back "to properly manage the pace and intensity of policies".

We maintain our comment that "the policy rate hiking cycle looks close to an end", but we

do not rule out the possibility of a fourth interest rate hike in Q3 11. We currently forecast

CPI inflation will ease to below 6% in July (5.8%) and below 5% in September. However, if

inflation turns out to be higher, it would make another rate hike more likely, in our opinion.

Rahul Bajoria


Jian Chang

+852 2903 2654

[email protected]

Figure 1: 7d repo rate surged following Chinas June RRR hike Figure 2: Chinas inflation/growth mix warrants a rate hike

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Jul -10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11

% 3m CB bill issue rate

7d Interbank repo rate

4

6

8

10

12

14

16

01 02 03 04 05 06 07 08 09 10 11 12

-4

-2

0

2

4

6

8

10

GDP (% y/y)

CPI (% y/y, RHS)

1y benchmark deposit (%pa, RHS)

June

Projection

Source: CEIC, Barclays Capital Source: CEIC, Barclays Capital

PBoC delivers another rate hike

this week, the third increase

in 2011

Monetary Policy focus is on

stability,flexibility and the pace

and intensity

We see outside risks of another

25bps rate hike in Q3


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7 July 2011 7

Emerging Asia: Inflation remains sticky

There are more signs that regional inflation remains sticky. In Taiwan, consumer prices rose

1.93% y/y in June, exceeding expectations. It also accelerated from the 1.66% print in May

and was the highest reading since November 2008. On a 3m/3m saar basis, our estimate of

core inflation held steady at 1.4% m/m, the same pace as May. Even so, we believe the

trend for core inflation is up, driven by the structural revival in discretionary consumer

spending, which is being fuelled by nine consecutive quarters of q/q growth (five in double

digits), stronger job prospects, resurgent property values and an influx of tourist from

mainland China. We expect the trajectory of inflation to worsen, with headline readings

likely to top out at above 2% in the coming months. The main factor is the fading of the

downward distortion from lower agricultural prices. Also, importantly, given the recent hot

weather, peak utility rates took effect from June.

In the Philippines, while headline inflation surprised on the downside, core price pressures

continue to build. Given the acceleration in core inflation, we maintain our view that Bangko

Sentral ng Pilipinas will raise the policy rate 25bp, to 4.75%, in July given the uptrend in core

prices and the risk that headline inflation will breach the top end of the 3-5% target band in

the coming months.

The week ahead: Focus on inflation and central bank meetings

We expect Chinas June inflation to rise to 6.3% y/y, on higher food prices and a low base. We

think PPI inflation is likely to remain elevated, at 7.1% y/y. We believe growth is moderating at

the margin, and look for GDP to expand 9.4% y/y in Q2. We expect Junes trade data to show

ongoing moderation in China, but nominal imports may hold up given elevated commodity

prices. On the monetary policy front, we expect the Bank of Korea and Bank Indonesia to leave

rates unchanged, but expect the BoK to sound hawkish as the governments focus shifts to

cost-of-living concerns with the start of the election campaign. In Indonesia, we expect BI to

stay on hold, but we expect it to raise rates in Q3, given rising core price pressures. We expect

the Bank of Thailand to deliver a 25bp rate hike, in line with the consensus view. Finally, in

India, we expect May industrial production to show modest improvement, but inflation is likelyto rise to 9.5% in June, given the recent hike in domestic fuel prices.

Figure 3: Core inflation is above historical levels in Taiwan Figure 4: Inflation expectations are elevated in Korea

-3

-2

-1

0

1

2

3

4

5

Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

TW: Core CPI, % 3m/3m saar

-0.3

-0.1

0.1

0.3

0.5

0.7

Jun-08 Jun-09 Jun-10 Jun-11

120

130

140

150

160

KR: Core inflation (% m/m, sa)Expected change in prices in 6 mths (RHS)

\

Source: CEIC, Barclays Capital Source: CEIC, Barclays Capital

Strong momentum in growth is

spilling over into higher wages

and rising core price pressures in

Taiwan

Core inflation is also rising

in the Philippines

Next week: Monetary policy

meetings in Korea, Indonesia

and Thailand


8/36


7 July 2011 8

MACRO OUTLOOK: EMERGING EUROPE, MIDDLE EAST & AFRICA

Doves rule as inflation peaks and growth slows

Global commodity prices are moderating and prospects for local harvests areimproving.

This, along with slowing growth and greater risks of a harder landing globally, seemsto have lent support to more dovish attitudes at central banks across the region.

We had highlighted in our recent Emerging Market Quarterly: Summer Storms, 21 June that

central banks in the region now face a different outlook than earlier this year. While monetary

policy in core markets remains generally dovish, pressures from commodity prices seem to have

abated and growth is clearly slowing, with an increased risk of a harder landing in H2. Against

the backdrop of ongoing rate setting meetings and many CPI and IP releases this week and next,

we review the monetary policy and growth-inflation developments in the region below.

In Russia this week, June headline CPI surprised to the downside, with inflation slowing to

9.4% y/y (9.6% y/y in May) on the back of further moderation in food price inflation. This islikely to continue for a few more months, as last summers food price shock created

favourable base effects and this years harvest for the region (including central Europe) should

be good. Although we remain watchful of the still rising core inflation, we now expect the CBR

to pause, keeping policy rates on hold through 2011. Aside from inflation, we anticipate that

Russias IP will moderately accelerate next week. However, overall IP growth has disappointed,

given the strong support from oil, and the growth outlook remains mixed.

Food prices also surprised to the downside in Turkey, where the m/m decline in June of over

6% more than compensated for the increase in May, bringing the headline print to 6.2%

y/y, significantly below expectations. Although core inflation measures are still rising, the

CBTs communication on the back of June inflation has turned seemingly more dovish than

before, increasing the chance that the policy rate may not rise this year (but note we stillexpect a 75bp in Q4). However, while high food price increases last summer also provide a

favourable base effect in Turkey, pass-through from the weaker TRY could partly offset this.

Next weeks data are likely to reflect another dilemma for Turkeys policymakers - May IP

could slow further due to weaker external demand, while the May current account deficit is

likely to widen even more due to still strong domestic demand.

Gina Schoeman


Christian Keller

+44 (0) 20 7773 2031

[email protected]

Figure 1: EEMEA food inflation expected to have peaked Figure 2: and growth is slowing as well

Food inflation (% y/y)

-5%

0%

5%

10%

15%

20%

25%

Jul-07 Jul-08 Jul-09 Jul-10 Jul-11

Hungary Poland Russia Turkey

Industrial production (% y/y)

-30%

-20%

-10%

0%

10%

20%

30%

May-07 May-08 May-09 May-10 May-11

HungaryPolandRussiaTurkey

Source: Haver Analytics Source: Have Analytics

Russia inflation decelerated

slightly last month; we nowexpect the CBR to keep rates on

hold for the remainder of 2011

amid disappointing growth

The Turkish central bank

appears to have turned more

dovish on a surprise drop in June

inflation due to lower food prices
https://live.barcap.com/go/publications/content?contentPubID=FC1723084https://live.barcap.com/go/publications/content?contentPubID=FC1723084


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7 July 2011 9

Polands NBP kept rates on hold last week (at 4.5%), as was widely expected, indicating that

it first wanted to assess the impact of the measures taken so far, having hiked policy rates

by 100bp this year (we expect one more 25bp hike this year). We note that real rates

remain in negative territory with May headline CPI at 5.0 y/ywe expect a slightly lower

print of 4.8% for next weekand core inflation still rising. This also fits into the pattern of

central banks behaviour we discussed in our most recent EM Quarterly, namely that actual

inflation may not moderate towards official targets rather, central banks may becomeincreasingly willing to look through above-target prints as their concerns about growth

increase, and the prospects for lower commodity prices rise. Last but not least, Serbias NBS

even cut its policy rate by 25bp this week to 11.75% on the back of an improved risk

premium (EU accession candidacy), moderating inflation, and as it had hiked rates by

450bp from August 2010 to April 2011.

For next week, we expect favourable food price base effects to also support some

moderation in Hungarian June inflation to 3.7% y/y. Against the backdrop of still very weak

domestic demand, we estimate that inflation will moderate towards the 3.0% target in

2012. Indeed, Hungarys May IP surprised to the downside this week, with its print

suggesting a m/m production decline of 0.8% on seasonally adjusted terms. While this may

spark a debate about possible rate cuts later this year, the NBHs MC minutes released thisweek suggest that this is not very likely. The NBH seems concerned not only about inflation

expectations (which have still not adjusted downward) but also about the implications a

reduction in carry could have on HUF. We maintain our view that rates will likely remain on

hold (at 6.0%) for the remainder of the year.

In Israel, we expect a slight moderation in CPI inflation to 4.0% y/y (4.1% y/y previously).

However, given the still robust growth, we forecast that the BoIwhich started its hiking

cycle in August 2009will further hike rates to bring inflation expectations into the middle

of the 1-3% range. We estimate the policy rate will rise by another 75bp (25bp each

quarter) to a final rate of 4.0% in Q1 12. In South Africa, we expect the SARB to start hiking

rates only in January 2012 (far later than most EEMEA countries). We then estimate 200bp

in magnitude for the hiking cycle, but caution that the SARB may chose a stop-and-gopattern, rather than the traditional hike at every meeting. Similarly to other central banks in

the region, it could consider the still below-potential GDP and the low core inflation.

Polands NBP kept rates on hold

having raised them by 100bp

already this year

Hungarian inflation is declining,

but remains above the target;

and we expect the central bank

to remain on hold for the

remainder of 2011

Figure 3: Turkey: June CPI fell, but C/A deficit still an issue Figure 4: The SARB is expected to stay on hold in 2011

3

4

5

6

7

8

9

10

11

12

13

Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

0

10

20

30

40

50

60

70

CPI inflation (%, y/y)

Turkey CA deficit (12 months ma; USD bn) RHS

0

2

4

6

8

10

12

Jan 09 Jul 09 Jan 10 Jul 10 Jan 11

Headline CPI Core inflationRepo rate %

3% floor

6% ceiling

The SA Reserve Bank has not hi

we only expect this in January 2

will the pace be consecutive or

Source: Datastream Source: Datastream

We expect a slight moderation in

Israel inflation; gradual rate

hikes to continue


10/36


7 July 2011 10

MACRO OUTLOOK: LATIN AMERICA

At war again? Yes, but not for long.

As commodity price pressures dissipate and headline inflation moves south, thecrusade against currency appreciation is starting to re-emerge in the Latin region.

The outlook for core is not as rosy as headline CPI, and in countries such as Brazil andColombia, we doubt the governments will use the FX channel to control inflation.

The Brazilian Finance Minister, Guido Mantega, was once again at the forefront of economic

news this week, claiming that the currency wars were not over. Food and fuel prices are

now helping bring headline inflation down across most of the region. Furthermore, there

has been some risk decompression due to positive developments in the Greek sovereign

debt crisis, which reignited some capital flows towards the region leading to FX strength..

While this is unquestionably the backdrop for Minister Mantegas comments, we think the

statement express more than just an attempt to control the appreciation of the currency. In

our view, they also state that inflation has moved to the back burner and is not at the top of

the priority list of the Brazilian government. While other central banks across the region may

have a much more comfortable inflationary backdrop, we believe the Brazilian case is

different, with only a temporary respite on the inflation front. Hence, a stronger BRL is not

only welcome, but necessary to keep inflation within the target range.

Figure 1 shows that with the exception of Chile, m/m inflation prints have been losing

momentum this year. Lower food and fuel prices have been making their way out of the

index, helping bring headline inflation down and/or keep it low. These effects are lagging in

Chile, but we expect them to start appearing as of the June release (due out Friday, July 8). In

contrast, a common trend of rising core has been observed across the region (Figure 2).

And, even though in Peru the core trend spiked due to a strong 5.0% (SAAR) reading in

June, from 2.1% in May and 1.0% in April, shifting it above the 2.0% official target, it is in

Brazil that the risks of missing the target remain high.

Alejandro Arreaza

+1 212 412 [email protected]

Marcelo Salomon

+1 212 412 5717

[email protected]

The good season of low inflation

in Brazil is only temporary, and

the government still needs the

FX channel to help fight inflation

Figure 1: Less headline inflation. Figure 2: with core trend sturdy or moving up

-1.0

-0.5

0.0

0.5

1.0

1.5

Jan-10 May-10 Sep-10 Jan-11 May-11

Brazil Chile ColombiaMexico Peru

% m/m

-5.5

-3.5

-1.5

0.5

2.5

4.5

6.5

8.5

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

Brazil Chile ColombiaMexico Peru

3MMA % m/m saar

Source: Haver, Barclays Capital Source: Haver, Barclays Capital


11/36


7 July 2011 11

In Brazil, headline inflation dropped to 0.15% in June (slightly above what we and the markets

were expecting: 0.10% and 0.07%, respectively), but core remained very sticky. The average

of the three measures of core inflation tracked by the BCB rose to 6.5% (SAAR), from 6.1% in

May. We believe headline inflation should gradually move back to the 0.50% range in August-

September and that core will remain stubbornly high. This means that we do not expect

downward surprises as we head out of the northern hemisphere summer.

It is also interesting to note that the downward inflation surprises of the past months have

been smaller and shorter lived than the ones observed last year. Figure 3 shows that only in

Colombia and Mexico were markets really caught by surprise by the intensity of the

downward movement of inflation. And quite differently from last year, in this case the index

is moving back up just as fast as it moved down. Meanwhile, in Chile and Brazil, there was

little, if any, downward deviation from the expected outcome.

So can authorities really dispose of the tightening effects that come with further exchange

rate appreciation? We believe not. Figure 4 shows that the COP and BRL experienced the

strongest bouts of appreciation in the very short term (a period in which we believe Latin

central bankers started to use the FX channel in the fight against inflation). Given our more

bearish outlook for inflation in Brazil, we believe it is unlikely that Minister Mantega will

resort to further capital control in the short to medium run, and we continue to see the

USD/BRL slipping to the 1.50 level.

In Colombia, even though inflation remains well behaved and close to target, we do see

signs that the recent pressure is related more to domestic demand than to global

commodity cycles. President Santos has already signalled his concern with peso

appreciation were Banrep to continue tightening monetary policy. This seems to be reviving

internal board discussions on macro-prudential measures, at a time when, in our view,

Banrep will need to continue to tighten and lift the target rate to 5.0% by year-end. If the

demand-driven inflationary pressures become more intense, we believe Colombian

authorities would prioritize this over fighting the stronger peso.

Hence, despite the pickup in rhetoric, we believe Mantegas second wave of currency warsmay be much shorter than originally planned.

Food and fuel prices are helping

bring headline inflation down,

but core measures are not

following suit

Despite the rhetorical

component, we believe

Colombia and Brazil will

continue to use the FX

channel to help fight inflation

Figure 3: Inflation surprised less than last year Figure 4: COP and BRL experiencing the largest appreciations

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Jan-10 Jun-10 Nov-10 Apr-11

Brazil Mexico Chile Colombia

SD

90

92

94

96

98

100

102

104

Mar-11 Apr-11 May-11 Jun-11 Jul-11

BRL CLP COP MXN PEN

Source: Barclays Capital Source: Bloomberg, Barclays Capital


12/36


7 July 2011 12

MACRO OUTLOOK: EMERGING MARKETS CORPORATE CREDIT

Top of the range warrants cautious longs

We recommended taking profits on shorts during what we believed was going to be avolatile June (see Trimming the Bears Claws: Scale back shorts into global weakness,May 27 2011). Spreads are wider now, having priced in further peripheral European

turmoil and ongoing weak US data.

US data are gradually improving (especially versus lowered expectations), andalthough the European problems linger, risk of a near-term Greek debt restructuring

has abated.

Cautiously legging into some high grade credit now makes sense. That said,macroeconomic uncertainties, the limited selloff, and dwindling policy options should

cap ultimate upside. By the beginning of Q4, we expect the outlook for total returns

to begin to look more muted, as spreads should be too tight to rally enough to

compensate investors for rising Treasury yields.

Week in review

Better sentiment compared with last week was more evident in the opening of the primary

market than in spreads, which were roughly unchanged. Cosan tapped its 8.25% perp for

$200mn, Cemex came to market for $650mn after pulling a deal two weeks ago amid

market volatility, and a number of new deals were announced.

In line with our expectation, Asian borrowers took advantage of a period of strength to tap

the primary market. We expect the supply pipeline to build up quickly. While high cash

levels should absorb some of this potential issuance, we think expectations of a deluge of

supply will likely cap performance of the asset class.

We published a constructive view on Cemex (Cemex Credit Story Intact: Earnings weakbut assets valuable) and Pacific Rubiales (Pacific Rubiales upgraded by S&P bond offer

value to Ecopetrol).

Aziz Sunderji


Juan C. Cruz

+1 212 412 3424

[email protected]

Krishna Hegde

+65 6308 2979

[email protected]

Avanti Save


Figure 1: Peripheral problems will stay in the headlines formany more quarters

Figure 2: but the sensitivity of EM corporate credit to theseheadlines is diminishing

0

5

10

15

20

25

30

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

Public Sector Financing Need (EUR bn)

EU/IMF Disbursements (EUR bn)

Financing gap (to be met with cash, asset sales, private

market financing)

200

250

300

350

400

450

500

0 50 100 150 200 250 300

EM corporates OAS

SovX

May 2010

May 2011-now

Current

Source: Barclays Capital Source: Markit, Barclays Capital
https://live.barcap.com/go/publications/content?contentPubID=FC1716487https://live.barcap.com/go/publications/content?contentPubID=FC1726693https://live.barcap.com/go/publications/content?contentPubID=FC1726693https://live.barcap.com/go/publications/content?contentPubID=FC1726792https://live.barcap.com/go/publications/content?contentPubID=FC1726792https://live.barcap.com/go/publications/content?contentPubID=FC1726792https://live.barcap.com/go/publications/content?contentPubID=FC1726792https://live.barcap.com/go/publications/content?contentPubID=FC1726693https://live.barcap.com/go/publications/content?contentPubID=FC1726693https://live.barcap.com/go/publications/content?contentPubID=FC1716487


13/36


7 July 2011 13

EM corporate credits declining beta to Greece

The Greek government passing a vote of confidence and the Medium Term Fiscal

Programme (MTFP) have diminished the probability of a near-term restructuring. However,

ultimately, a substantial reduction in the NPV of outstanding Greek debt will likely be

required. Between now and then, Greece will have to pass quarterly monitoring imposed by

the IMF in order to continue to receive funding. After only nine months, Greece was unable

to meet IMF targets set a year ago; a similar progression cannot be ruled out this time.

Investors should therefore expect Greek headlines to cause spread volatility every three

months from now until an NPV reduction is agreed. However, in our view, this does not

warrant sitting on the sidelines in EM corporate credit. In particular, we believe the

sensitivity of the asset class to the problems in the European periphery is diminishing

(Figure 2). Thus, although we expect a number of short- and long-term disruptive

developments from Greece and other European sovereigns, we do not think this justifies an

underweight in EM corporate credit.

Corporates versus sovereigns: Cheap, but cheap enough?

EM corporates have been underperforming sovereigns since mid-April (Figure 3). We

believe this was a function of a reversal of EM inflation concerns, which caused EM fixedincome outflows late last year and throughout Q1 this year and coincided with corporate

outperformance versus sovereigns. Moreover, recent corporate underperformance has been

exacerbated by a sharp pullback in risk appetite, which hurt higher beta EM corporates

more than sovereigns.

In our view, the performance of corporates versus sovereigns in EM is captured by the flows

data in particular, the stronger the US HY corporate credit flows relative to EM fixed income,

the better the performance of EM corporates (whose price action follows global credit more

closely than EM sovereigns) versus EM sovereigns (Figure 4). While US flows have a

contemporaneous relationship with credit performance, there is some evidence (Figure 4) to

suggest that US HY flows versus EM fixed income flows have a slightly (three-week) leading

effect on the performance of EM corporates versus EM sovereigns. This relationship andrecent flows data suggest there is room for further cheapening of corporates against

sovereigns, though last weeks uptick in US HY inflows hints at an end to this trend.

Figure 3: EM corporates have underperformed EM

sovereigns

Figure 4: This trend has room to run but the end is in sight:US HY inflows should recover along with risk appetite

200

250

300

350

400

450

Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

EM: Sovereigns - OAS EM: Corporates - OAS

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Apr-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11

0

20

40

60

80

100

120

140

160

EM Corp OAS minus EM Sov OAS (3wk lag, RHS)

US HY flow minus EM bond flow (USD bn)

Source: Barclays Capital Source: Barclays Capital, EPFR


14/36


7 July 2011 14

Breaking the yield window

Over the longer term perhaps by the beginning of Q4 we expect the outlook for EM

corporate credit total returns to begin to look less promising.

Rates rallied sufficiently in 2011 to offset bouts of spread widening, leading most EM

corporate investors to register modest performance on a total return basis (the Barclays

Capital EM corporate index returned (total) 3.92% YTD). But we expect that as spreads

tighten and approach a level from which further tightening is more limited, total returns will

diminish (and potentially turn negative) due to rising UST yields.

If the current soft patch is indeed a mid-cycle slowdown, 2011 may look somewhat like

2004. During that year and the next two (2004-06), total returns were positive, but low, asspreads tightened little and yields rose. 2011-13 could be similar, though we also note that

our rates strategists expect only modest (and gradual) rising UST yields (3.5% in Q1 and Q2

2012 in UST 10y).

Figure 5: The mid-late recovery stage of the previous cyclehad low total returns (US high grade credit shown)

Figure 6: In 2011, spread widening has been offset by risk-free yields falling; this should cease once spreads hit a floor,perhaps near 250bp

-20

-15-10

-5

05

101520

2530

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Corp credit return Risk free return Total Return

% return

150

170

190

210

230

250

270

290

310

330

350

Jan-10 Apr-10 Jul -10 Oct-10 Jan-11 Apr-11 Jul -11

250

270

290

310

330

350

370

390

410

430

450

Maturity matched UST EM corporates OAS (RHS)

Source: Barclays Capital Source: Barclays Capital


15/36


7 July 2011 15

STRATEGY FOCUS: THAILAND

A tactical long

Puea Thai party election win paves the way for Yingluck Shinawatra to become the new

PM. While we view the election result as constructive in the near term by reducinguncertainty, we do not believe it resolves the longer-term issues in Thai politics. But in the

short term, we expect the markets focus to switch back to the economy.

The Yingluck Shinawatra-led Puea Thai party (supported by the red shirts), which is linked

to ex-PM Thaksin Shinawatra, emerged victorious from the July 3 general election, winning

a simple majority of 265 seats out of 500, according to the preliminary results. This was

below the 313-seat win forecast by some exit polls and fewer than the 460 seats the

Thaksin-led party won in 2006. The official results are expected to be released on 12 July,

according to the Election Commission. We do not expect any major change from the initial

results. Although the election was peaceful, the national police adviser said that the police

would remain vigilant and provide protection to over 400 candidates to counter any post

election-related violence (see EC: Election is transparent, official result will be known in a

week, NNT, 3 July 2011.)

In the lead up to the voting, Puea Thai was already courting coalition partners. According to

PM-elect Yingluck, four smaller parties including Chart Thai Pattana and Chart Pattana Puea

Pandin will join Puea Thai in government adding 34 more seats, giving it 299 seats and a

larger majority in parliament. Other smaller parties may also join later. The selection of

cabinet members is likely to begin soon and could be completed within the next two weeks.

Despite Puea Thai's victory, the political outlook remains unclear. Some of the main issues in

Thai politics, especially the granting of an amnesty to former members of the 2006

government of Thaksin Shinawatra, are unlikely to be resolved in the near term. But given

Puea Thai's clear win, the risks of intervention by the judiciary or military in the near term

have reduced significantly. Shortly after the initial poll results were announced, DefenceMinister Prawit Wongsuwon reiterated that the armed forces would accept the peoples

decision, and would not intervene in the electoral process (All eyes turn to army's reaction,

Bangkok Post, 5 July 2011).

Rahul Bajoria


Ju Wang

+65 6308 2801

[email protected]

Avanti Save

+65 6308 3116

[email protected]

Figure 1: Election results and proposed combination of Puea Thai-led government

Democrats, 159

Bhumjaithai, 34

Others, 8

Government, 299

Puea Thai, 265

Puea Pandin,

7

Others, 8

Chart ThaiPattana, 19

Source: Bangkok Post, Barclays Capital

Puea Thai wins general election

by a simple majority

New government will be a

coalition of five parties

Near-term stability is unlikely to

signal long-term reconciliation


16/36


7 July 2011 16

Beyond the election, we continue to believe that economic growth momentum in Thailand

is likely to slow in H2 11, given global growth concerns, weaker consumer confidence and

moderating investment. Negative newsflow around the recent election could also mean that

tourist arrivals do not pick up meaningfully in H2, which could, in turn, contribute to a

period of sluggish domestic demand. In this scenario, we believe the Bank of Thailand

would adopt a more cautious approach to further monetary normalisation. For now, we

expect the BoT to raise rates by 25bp in the meeting on 13 July, and possibly a further oneor two more hikes if inflation pressures were to increase significantly. We believe the THB is

likely to outperform in the coming month, helped by a resumption of equity inflows. But the

upside is likely to remain limited given deteriorating support from the balance of payments

and the likelihood of intervention by the central bank to moderate the pace of appreciation.

Given the decline in near-term risk premia we expect Thai government bonds to outperform

swaps and recommend paying 5y IRS versus buying 5y Thai government bonds (entry: 2bp;

current: 15bp; target: 32bp; stop: -12bp). Further, the risk of pro-growth fiscal policies and a

large expansion in spending programs by the new government is likely to trigger

expectations that monetary policy may need to stay tight, in our view. We believe an

increase in such expectations would keep IRS rates elevated. If implemented, increased

government fiscal spending could also imply higher bond supply in the next fiscal year,though the near-term impact would likely be limited given the low government debt

burden. In addition, if the THB started to outperform in a significant manner we think the

BoT would be likely to step in, which in turn implies that FX forward points could remain

elevated, enhancing the performance of bond-swap spread trades.

From a credit perspective, we recommend scaling into a long Thailand position via selling 5y

CDS, if spreads widen again to 130bp (on, say, an adverse reaction by the military; not our

base case). However, if the new government moves towards raising the issue of granting an

amnesty to former PM Thaksin Shinawatra and other politicians banned in 2007, the

political risks could start to rise again.

We see upside risks to our BoT

rate hike projections in H2

Figure 2: We expect bonds to outperform swaps Figure 3: Near term decline in risk premia

-40

-20

0

20

40

60

80

100

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Ja n-10 Jan-11

20d m.a. of 5y bond swap spread

60

80

100

120

140

160

180

Jul-2010 Oct-2010 Jan-2011 Apr-2011 Jul-2011

0

10

20

30

40

50

60

70

Malaysia (5yr CDS) Thailand Difference (RHS)

bp bp

Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital

We expect 5y bonds to

outperform swaps

We see good risk-reward in

selling protection on Thailand if

spreads widen again to 130bp


17/36


7 July 2011 17

STRATEGY FOCUS: CHINA

China rates: 1y deposit rate to act as a floor for 7dfixing; curve to remain flat

This is an excerpt from an Instant Insight of the same name, published 7 July 2011.

We expect the curve to remain flat in the near term on tight systemic liquidity. The 1y

deposit rate will serve as a floor for money market rates in a tight liquidity environment.

We suggest holding short-end paid positions for carry but would look for opportunities to

enter receive positions around 4.2-4.3%.

Rate hike was not a surprise

After market closed yesterday, China announced a 25bp increase in the 1y deposit and

lending rates, the fifth hike in the current cycle and the third in 2011. The increase takes the

1y deposit rate to 3.5% and 1y lending rate to 6.56%. The hike was symmetrical (although

there was no increase in the demand deposit rate), which, in our view, signals an effort to

protect banks' earnings, given the recent negative news affecting the banking sector (see

our equities analysts' report, China banks: symmetrical interest rate hike positive for China

banks' NIM/earnings, July 6, 2011).

For the rates market, the hike was not unexpected given: 1) the recent run-up in pork prices

has led to widespread expectations that June CPI inflation will exceed 6% y/y; 2) the upward

adjustment in the PBoC's 1y central bank bill yield to 3.4982% over recent auctions, almost

25bp rate over 1y deposit rates, was widely taken as a preparation for rate hike; and 3) the

PBoC's emphasis on inflation pressure in its regular Q2 policy meeting sent a hawkish signal

to the market. However yesterday's increase came earlier than expected - it was widely

expected in mid-July, when the June CPI is scheduled to be released and the State Council

will hold its mid-year meeting to assess the economic situation. In our economists' view,

this suggests yesterday's rate hike was an overdue rate hike.

Policy stance has yet to loosen

Our economists maintain their view that monetary policy is not yet in a position to be

loosened. They see room for one more rate hike, but think the near-term risk of an RRR

increase is limited given tight interbank liquidity conditions (and the backdrop of a record

high reserve requirement ratio), strict CBRC regulations (daily L/D ratio since June) and the

lower amount of maturing OMOs in H2 11. However, one or two more RRR hikes are

possible in the second half of the year, depending on the size of FX inflows (see China: The

much-anticipated interest rate hike to end the tightening cycle, or not?, July 6 2011).

Tight systemic liquidity to keep interest rate curve flat for nowAccordingly, we reiterate our view that the curve will stay flat in the near term given tight

systemic liquidity. A temporary easing in liquidity could occur, but likely will not last until

the current policy stance is reversed. Interestingly, post-decision market moves have shown

more upward pressure on short-end rates than long-end rates, which tends to happen

when systemic liquidity is tight and the rate-hike cycle is close to end. In our view, the

upward adjustment in short-end IRS indicates that investors believe the 1y deposit rate will

serve as firm floor for money market rates in a tight liquidity environment, as there is little

excess liquidity to be lent out below banks' long-term funding cost. As the same time, we

Ju Wang+65 6308 2801

[email protected]
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18/36


7 July 2011 18

believe the relatively muted reaction in the long end probably reflects concerns about

growth, as well as relatively sanguine view towards longer-dated bonds now that the rate-

hike shoe has finally dropped. We see limited upside in long-end yields, as tight credit and

monetary conditions are likely to cap growth and inflation expectations.

Investors should still watch out for receivers

We suggest holding short-end paid positions as carry is favourable. The 4% level reached in

late February is likely to serve as the near-term peak for 1y paid positions, but downside

should be floored by the higher funding cost. As the 1y deposit rate is 3.5%, we think it is

unlikely that 7day fixing can fall below 4% in the near term, which implies a floor for the 1y

IRS at 3.75%. We think liquidity conditions will eventually ease in H2 11, once inflation

peaks after July on favourable base effects, particularly as the PBoC emphasised "stability"

and the "pace and intensity" of polices in the minutes of its policy committee's Q2 meeting.We believe 4.2-4.3% is good level to position for 5y receivers. We also think receiving the

1s2s5s butterfly is a low-beta strategy to position for such a scenario and offers good carry

in a tight liquidity environment. However, considering the high transaction costs in China's

NDIRS market, we feel investors need to build such a position via different steps.

Figure 1: 7-day repo fixing, 1y deposit rate, 1y central bank bill yield, and 1s5s ND IRS slope

-

2.0

4.0

6.0

8.0

10.0

12.0

Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11-50

-

50

100

150

2007day repo 1y depo1y CB yield (primary market) 1s5s repo IRS slope (bp, RHS)

Source: CEIC, Bloomberg, Barclays Capital

Figure 2: 1s5s slope and 1s2s5s butterfly, bp

-100

-80

-60

-40

-20

-

20

40

60

Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11

-50

-

50

100

150

2001s2s5s IRS butterflies 1s5s repo IRS slope, RHS

Source: Bloomberg, Barclays Capital


19/36


7 July 2011 19

STRATEGY FOCUS: EM SOVEREIGN CREDIT

Beta-driven shifts in positioning

We update our EM benchmark credit Overweight/Underweight analysis to incorporatedata up to the end of May, based on benchmarked EM dedicated real money mutualfund allocations (the data are published with a one month lag). The difficult risk

environment in May, with a further deterioration in the euro area periphery situation and

softer global economic data, has clearly affected allocations. Higher-beta credits such

as Venezuela and Argentina in LatAm, Ukraine and Russia in EEMEA and Indonesia in

Asia saw their allocations decrease while lower-beta credits benefitted, with Brazil and

Mexico the largest beneficiaries. Venezuela has joined Turkey, Philippines and Lebanon

as the largest Underweights.

A comparison of Barclays Capital EM sovereign Overweight/Underweight views withmarket Overweight/Underweight positioning as of end-May reveals some interesting

insights (Figure 1). As advocated in our Emerging Markets Quarterly: Summer Storms,

21 June 2011, we think that a prudent view on risk taking is warranted over the next

weeks. We believe, however, that investors positions are overly defensive on thePhilippines, Venezuela and Turkey, providing technical support for our positive view on

these credits.

Specifically, we recommend adding exposure to Philippines versus Indonesia and, driven bythe recent developments around President Chavez, also suggest adding risk to Venezuela

(with a preference for cheap shorter-dated paper, such as the PDVSA 17N, at present). We

recently upgraded Turkey to Overweight and, given the flatness of the curve, continue to

recommend the 5y sector in particular. For all three credits, defensive positioning should

constitute an important anchor over the next few weeks.

Figure 1: BarCap views vs market positioning

BarCap/Market UW

El SalvadorVietnamBulgariaGabonEgypt

RussiaMexico

BarCap OW, Market UW

PhilippinesTurkey

VenezuelaPanama

BarCap UW, Market OW

Indonesia

BarCap/Market OW

BrazilUkraineGhana

Sri LankaDom. Republic

Note: Credits with Barclays Capital Market Weight recommendations are not shown.Source: EPFR Global , Barclays Capital

George Christou

+44 (0) 20 7773 [email protected]

Andreas Kolbe

+44 (0)20 3134 3134

[email protected]

Avanti Save

+65 6308 3116

[email protected]

Donato Guarino


Alanna Gregory

+1 212 412 5938

[email protected]
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20/36


7 July 2011 20

Allocation changes mirror risk environment

The difficult global risk environment in May was clearly reflected in Global EM credit

investors risk allocations. The highest beta credits, Venezuela and Argentina, both saw

decreases in allocations. While in the case of Argentina, investors still hold a significant

Overweight, Venezuela has become one of the largest Underweights in the Global EM credit

space. In the EEMEA region, Ukraine has been negatively affected, similarly to Russia which

is significantly exposed to commodity prices and historically, has had high correlations toglobal market drivers. In Asia, while investors remain marginally Overweight Indonesia,

positions have been reduced.

Among the re-allocation winners some safe-haven credits stand out, most notably low-beta

credits in LatAm such as Brazil, as well as some names with particularly low correlations to global

markets/events, such as Lebanon (although the political developments and tail risks in the latter

would make us reluctant to hold more than a Market Weight allocation). Brazils status as a safe-

haven credit manifested itself in recent periods of risk aversion and crises. For example, Brazil

outperformed notably during the Lehman crisis, holding up remarkably well compared with

other high grade credits. These historical performance patterns have likely underpinned the re-

allocations into Brazil in the fragile market environment in May, as investors switched into Brazil

and out of higher-beta credits such as Argentina. The increase in allocations to Brazil was also

likely fuelled by the significant buy-backs of the Brazilian Treasury (especially at the short end of

the curve) which further attracted investors to this name. We maintain our Overweight

recommendation on Brazil and highlight that the recently announced supply (expected to be

USD1.52bn) is likely to be easily absorbed by the market.

Helpful positioning: Add to Philippines, Turkey, Venezuela

While we think that a prudent approach to risk-taking over the likely volatile summer period

seems justified, we believe investors positions on selected credits are overly cautious.

Among the Asian sovereigns, we switched to an Overweight position in the Philippines from an

Underweight in our Emerging Markets Quarterly: Summer Storms, June 2011, with a

corresponding Underweight in Indonesia. Given our assumption for benchmark spread widening,

Indonesian bonds tend to be relatively more vulnerable to the downside, while the Philippines is

better anchored by onshore investors. Also, we expect the Philippines sovereign to receive an

outlook upgrade in H2 11, as fiscal consolidation and debt reduction remain on track.

Investors have re-allocated from

higher-beta credits

into safe havens such as Brazil

and into some credits with low

correlations to global

market drivers

Figure 2: Over/Underweights in EM credit space as of end-

May 2011

Figure 3: Investors have re-allocated from higher-beta

credits into more defensive and lower-beta credits

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

Arge

SOAF

Ukra

Indo

Ghan

Peru

Dom.

Sril

Braz

Mala

Nige

Colo

Gabo

Egyp

Croa

Bulg

Viet

Elsa

Pana

Hung

Chil

Pola

Russ

Mexi

Vene

Leba

Turk

Phil

OW/UW May

overweight

underweight

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

Mexi

Braz

Hung

Peru

Leba

SOAF

Nige

Phil

Colo

Bulg

Viet

Elsa

GaboSril

Egyp

Turk

Croa

Ghan

Dom.

Chil

Pana

Mala

Indo

Russ

Vene

Arge

Pola

Ukra

Diff btw May and April 2011

more OW/less UW

more UW/less OW

Source: EPFR Global, Barclays Capital Indices Source: EPFR Global, Barclays Capital Indices

Philippines bonds are better

anchored by onshore investors

than Indonesian bonds


21/36


7 July 2011 21

The Philippine cabinet approved the 2012 national budget last week. The budget is 10.4%

larger than this years. The administration also extended the conditional cash transfer

program (4Ps) to 3mn households in 2012 from 2.3mn in 2011. The press release highlights

that the disbursements to target households this year are to be completed by September.

Overall, we believe the budget will further improve confidence in the administrations ability

to continue the fiscal consolidation process and ensure quality spending on infrastructure

projects. Budget and Management Secretary Abad provided some clarity on governmentspending, saying a review of costs and efficiencies among government agencies will result

in better quality government spending. Disbursements for May were up 15.7% m/m.

In LatAm, given the recent idiosyncratic developments (it was confirmed that President

Chavez has been diagnosed with cancer), we have upgraded Venezuela to Overweight.

Although the credit has already outperformed significantly, Chavez health issues represent

a challenge for the government ahead of the presidential election, as the illness will likely

limit his ability to recover his declining popularity. Additionally, any possible successors

would be at a disadvantage with respect to the main opposition leaders, who have

seemingly shown more solid leadership. The possibility of a democratic transition may

continue to increase, providing additional support to Venezuelan assets. Against this

background, while we prefer cheap shorter-dated bonds at present, we would ultimatelylook to add (convexity) exposure at the long end of the curve.

Finally, we think that the defensive investor positioning in Turkey should provide an important

anchor for valuations. While Turkeys macro imbalances remain a cause for concern and we

remain cautious on Turkey local markets, we think that the countrys longer-term credit profile

remains strong and expect the sensitivity of credit markets to local markets, as seen earlier in the

year, to abate. Given the underperformance of the short-end of the Turkey cash curve versus

other global benchmark credits earlier in the year, partly driven by selling interest from local

banks in need of short-term FX liquidity, we continue to recommend the Turkey 16s, 17s. The

underperformance has only been very partially reversed recently and we think that, taking into

account the continued flatness of the Turkey cash spread curve, the 5y sector in particular has

further catch-up potential (Figure 5).

and we expect the Philippines

sovereign to receive an outlook

upgrade in H2 11

The idiosyncratic developments

in Venezuela should continue to

support Venezuelan assets

We think the short end of the

Turkey curve has further catch-

up potential

Figure 4: Beta considerations seem to have been a drivingforce behind re-allocations

Figure 5: Turkey shorter-dated bonds have catch-uppotential given ytd underperformance

Leba

HungSOAFBraz MexiIndo

PeruRussUkra

Arge

Vene

0.0

0.1

0.2

0.30.4

0.5

0.6

0.7

0.8

0.9

1.0

-0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8

Chg in OW/UW between May and April (ppt)

Excessreturnbeta

toSPXsince2010

-30

-20-10

0

10

20

30

40

Russia SOAF Turkey

short-end (Turkey 16s, SOAF 14s, Russia 15s)belly (Turkey 20s, SOAF 20s, Russia 20s)long-end (Turkey 40s, SOAF 41s*, Russia 28s)

Change in Z-sprd

since 31-Dec

Note: Allocation changes in May (x-axis) plotted versus betas of weekly excessreturns of countries in t he Barclays Capital Global EM Sovereign index, since2010 (y-axis). Source: EPFR, Barclays Capital

Note: *SOAF 41s since 31 March 2011. Source: Bloomberg, Barclays Capital


22/36


7 July 2011 22

EM DASHBOARD

George Christou +44 (0)20 777 31472 [email protected]

Alanna Gregory 212 412 5938 [email protected]

Description Entry date Entry Current Target Stop

P&L to target/

P&L to stop Analyst

Credit (11)Long Boden 15 22-Jun-11 690bp 652.3bp 600bp 750bp 0.54 Guarino

Long Lith 17s, buy Bulgaria, Latvia 5y CDS 21-Jun-11 30bp 10bp -10bp 50bp 0.5 Kolbe, Keller

Long Turkey 16s, 17s 21-Jun-11 205bp 205bp 170bp 230bp 1.4 Kolbe

Long Morocco 20s 01-Jun-11 260bp 245bp 220bp 300bp 0.45 Kolbe, Moubayed

Buy Panama Sell Brazil 5yr CDS 11-May-11 24bp 10.4bp 0bp 34bp 3.8 Arreaza, Grisanti, Guarino

Long PDVSA 17 New 28-Apr-11 72 74.93 78 67 0.39Arreaza, Cruz, Grisanti,Guarino

Sell Brazil Buy Mexico 10yr CDS 04-Apr-11 15bp 7.1bp -5bp 30bp 0.53 Guarino

Hungary 2s7s CDS steepener (DV01-neutral) 28-Mar-11 68bp 84bp 95bp 65bp 0.58 Kolbe

Long Ghana 17s 22-Mar-11 427bp 360bp 320bp 420bp 0.67 Kolbe, Markus

Long Ukraine 13s 07-Dec-10 525bp 420bp 320bp 450bp 3.33 Kolbe

Long Argentina EUR Warrant 06-Jun-10 6.05 14 16 9 0.27 Guar ino, Mondino

FX (14)

Buy 1m 1x1.5 USD/TWD put spread and sell 0.5 x USD 22-Jun-11 0.15bp 0.48bp 1.58bp 0bp 2.25 Verdi

Buy 3m 1x2 USD/CNY put spread 22-Jun-11 0.17bp 0.43bp 1.65bp 0bp 2.83 Verdi

Buy USD-EUR basket (60%-40%) vs. SGD outright 22-Jun-11 100 100.6 103 98.5 1.14 Verdi

Buy 1M and 3M PLN call digitals (strikes 3.90/85) 21-Jun-11 3.98 3.95 3.85 - 5 Chow

Buy 3M 1x2 CZK call sprd (strikes 23.95/00) 21-Jun-11 24.23 24.26 23 - 5 Christou

Long ILS vs. EUR, USD equal basket 21-Jun-11 4.16 4.14 4 4.24 1.4 Chow

Sell AUD/BRL 21-Jun-11 1.68 1.69 1.62 1.71 3.5 Melzi

Sell USDCLP 21-Jun-11 471.6 463.95 450 488 0.58 Melzi

Short CHF/MXN 21-Jun-11 14.01 13.78 13.5 14.2 0.67 Melzi

Short USDMXN 21-Jun-11 11.78 11.62 11.5 12.12 0.24 Melzi

Long EGP carry trade via 3M T-bills 19-May-11 5.95 5.96 5.93 5.98 1.5 Christou

Buy 3M USD call/TRY put spread (1.60, 1.70) 04-May-11 1.55 1.63 1.75 - 5 Chow

Long RON vs. EUR via 6M T-bills FX unhedged 22-Mar-11 4.16 4.21 4 4.3 2.33 Chow, Chwiejczak

Long Ghana 3y bond (FX unhedged) 07-Dec-10 13% 12.45% 9% 16% 0.97 MarkusRates (9)

Thailand 5y ASW 04-Jul-11 2bp 20bp 32bp -12bp 0.38 Wang, Rachapudi

Pay PLN vs. EUR 5y5y FWD 21-Jun-11 130bp 139bp 170bp 115bp 1.29 Chwiejczak

Long RUB CCS 2s5s Steepener 21-Jun-11 115bp 130bp 140bp 101bp 0.34 Chwiejczak

Own 6y ASW spread vs. (Apr 17 bond) 21-Jun-11 70% 65% 30% 110% 0.78 Chwiejczak

pay ZAR 12*15 FRA 21-Jun-11 6.8% 6.7% 7.5% 6.4% 2.33 Gable, Chwiejczak

Receive 5y OIS 09-Jun-11 7.8% 7.73% 7.55% 8.25% 0.35 Rachapudi

TRY Aug13 Linker (FX hedged) 08-Jun-11 123 122 124 120 1 Chwiejczak, Chow

Pay 1y OIS 02-Jun-11 8% 8.07% 8.2% 7.9% 0.76 Rachapudi

Receive 5y China 24-May-11 3.8% 4.08% 3.5% 4.2% 4.63 Wang

Brazil: Buy call ATMF, sell 2calls (13.15),buy call 28-Apr-11 12.75% 12.56%13.05

% 12.6% - Melzi, Salomon, Loureiro

CZK 2s10s IRS dv01 flattener 22-Mar-11 105bp 105bp 70bp 120bp 2.33 Chwiejczak

Pay TRY CCS 1y1y FWD 22-Mar-11 8.34% 8.64% 9% 8% 0.56 Chwiejczak

Closed Trades (14)

5y10y DV01-neutral UDI-TIIE steepener 21-Jun-11 64bp 78bp 80bp 74bp 30-Jun-11 Melzi

Buy Russia 5y CDS 16-Mar-11 138bp 150bp 170bp 120bp 30-Jun-11 Kolbe

Note: As of 06-07 July 2011 (trades are updated regionally). Methodology: P&L to target/P&L to stop is a measure of how much can be gained relative to how muchcan be lost. Both are calculated from the current value and reported in dollars. This measure does not take probabilities into account.Source: Barclays Capital


23/36


7 July 2011 23

EM FX VIEWS ON A PAGE

Currency Tactical bias Strategic directional view

Current strategy/

trades we like

Vol adj

6m

returns

Score

(1-5)

Emerging Asia

CNY Bullish We expect the USD/CNY to move lower as thegovernment authorities react to elevated inflation.

Buy 1x2 USD/CNY putspread (strikes 6.47 and6.35)

0.58 4.20

MYR Bullish Stronger growth, rising commodity prices, a healthy fiscalposition, and improved equity flows should lend supportto the currency.

0.38 3.85

KRW Bullish We believe that still-sizeable current account surplusesand a preference to contain imported inflationarypressures will drive USD/KRW towards 1025 by year-end.

0.30 3.40

TWD Bullish The CBC is more open to currency appreciation than inthe past. The TWD is likely to benefit from broad-basedUSD weakness.

Buy 1x1.5 USD/TWD putspread (strikes 28.90 and28.40) and sell 0.5x USDcall/TWD put (strike 29.30)

0.27 3.30

SGD Bullish The MASs concern relating to near-term inflationpressures is likely to support the SGD NEER.

Buy USD-EUR basket (60%-40%) versus SGD outright

0.29 3.15

THB Neutral We do not expect this years THB underperformance toreverse any time soon. Range-bound conditions are mostlikely.

0.24 3.00

PHP Neutral We think the central bank believes the REER is close to fairvalue. We expect a modest move lower in USD/PHPtowards 42.0 by year-end.

0.21 3.00

HKD Neutral Increasing CNY deposits onshore may result in theRMB-isation of the economy.

0.04 3.00

INR Neutral The INR remains fairly well supported, although medium-term issues related to the BoP persist.

0.19 2.70

IDR Bearish A shrinking current account surplus and high valuation

on a REER basis point to IDR underperformance.

-0.01 2.35

Latin America

CLP Bullish Supportive fundamentals: strong domestic demand,monetary tightening and rising copper prices.

Sell USD/CLP 3m NDF 0.32 3.40

PEN Neutral We see political uncertainty and FX intervention limitingupside, while technicals are supportive.

0.07 3.20

BRL Bullish We see supportive fundamentals and governmentacknowledgement of limitations of FX intervention,improved positioning and better risk environment.

Sell USD/BRL, sell AUD/BRL 0.27 2.85

MXN Bullish US activity has hit a soft patch, while domestic demandcontinues to improve. Improved positioning and riskaversion is fading.

Sell CHF/MXN 0.11 2.50


24/36


7 July 2011 24

Currency Tactical bias Strategic directional view

Current strategy/

trades we like

Vol adj

6m

returns

Score

(1-5)

Emerging EMEA

EGP Neutral/

Bullish

CBE should have enough of a reserve buffer to keep theEGP stable in the months prior to the elections.

Long EGP carry trade via 3m T-bills

0.58 3.70

TRY Neutral/

Bearish

Dovish monetary policy and a still-large C/A deficit will weighon TRY in periods of risk aversion. However, CBT concernsrelated to imported price pressures will likely limit anysignificant sell-off.

Buy USD call/TRY put spread,3m, 1.60-1.70 strikes

0.22 2.90

PLN* Bullish Continued MinFIn EUR selling, improving fiscal and C/Aoutlook and a resurgence in local government bond inflowsare all positive for PLN. A dovish NBP may cap appreciationpotential, however.

Short EUR/PLN via 1m (3.90)and 3m (3.85) digitals

0.37 3.20

RON* Bullish Abating euro periphery risks, improving C/A dynamics, CPIpressures, conversion of Eurobond proceeds, potentialprivatization flows, lighter positioning and appealing catchup all argue for RON appreciation.

Hold 6m T-bills FX unhedged 0.39 3.30

ILS Bullish A structurally robust BoP, further (though slower) policyrate hikes, relatively more tolerance to FX strength andpotential repatriation of foreign equity holdings by locals

(particularly in periods of risk aversion) are all positive forILS.

Long ILS vs. equally weightedEUR, USD basket

0.31 2.80

HUF* Neutral C/A surplus and a credible central bank are positive forHUF, but stretched positioning in local bonds, morepossibility of rate cuts (than hikes) and a likely slowing offlow momentum argue for a buy-on-dips strategy.

0.23 2.80

RUB Neutral Limited future tightening, less favorable seasonal BoP trends,persistent capital outflows, a moderation in oil prices andupcoming elections all point to slower RUB momentum.

0.05 1.95

CZK* Bullish Positive seasonal BoP income account effects, solid macrobalances, a healthy banking system and abating europeriphery risks should trigger the resurgence of a CZKstructural appreciation trend.

Buy 1x2 3M EUR put/CZK callspread (strikes 23.95, 23.00)

0.16 2.20

ZAR Neutral A renewed interest in SOAF assets leaves YTD flows net

positive, and although the narrow C/A deficit should beeasily funded through 2011, we expect some widening asinvestment starts to contribute more to the economy.

-0.04 1.85

UAH Neutral Depressed yields, uncertainties about the IMF program andthe balance of risks on the BoP leave the UAH moreexposed.

KZT Neutral Low/negative carry and dissipating oil momentum shouldkeep KZT range-bound in the coming months.

Note: * Versus EUR. The variable score is an index that ranks EM currencies according to the vol-adjusted returns, PPP valuation, carry, systemic risk, basicbalance/GDP and reserves accumulated over the past 5y/GDP. For more details on the trade recommendations, please see the EM Dashboard.Source: Barclays Capital


25/36


26/36


7 July 2011 26

DATA REVIEW & PREVIEW: ASIA

Rahul Bajoria, Jian Chang, Lingxiu Yang

Review of last weeks data releases

Main indicators Period Previous BarCap Actual Comments

Philippines: CPI (% y/y) Jun 4.5 5.0 4.6 Core prices continue to climb.

Taiwan: CPI (% y/y) Jun 1.7 1.7 1.9 Highest reading since November 2008.

Preview of week ahead

Saturday 9 July Period Prev 2 Prev 1 Latest Forecast Consensus

09:30 China: CPI (% y/y) June 5.4 5.3 5.5 6.3 6.2

09:30 China: PPI (% y/y) June 7.3 6.8 6.8 7.1 6.9

China: CPI: Driven by lower base and a pick-up in m/m momentum, with y/y pork and grain prices up 46% and 16.6%, respectively.

China: PPI: To remain elevated on a y/y basis, as suggested by a modest pick-up in the CRB index, but the m/m rate is expected

to ease.

Sunday 10 July Period Prev 2 Prev 1 Latest Forecast Consensus10:00 China: Exports (% y/y) June 35.8 29.9 19.4 18 18.6

10:00 China: Imports (% y/y) June 27.3 21.8 28.4 24.5 25.7

China: Exports to continue to slow, along with real imports. Nominal imports remain supported by still-elevated global

commodity prices.

Monday 11 July Period Prev 2 Prev 1 Latest Forecast Consensus

12:00 Malaysia: Industrial production (% y/y) May 5.2 2.9 -2.2 -1.8 -0.5

Tuesday 12 July Period Prev 2 Prev 1 Latest Forecast Consensu

Singapore: GDP, advance estimate (%y/y)

Q2 10.5 12.5 8.5 1.6 0.4

09:00 Philippines: Exports (% y/y) May 8.2 4.0 19.1 3.7

13:30 India: Industrial production (% y/y) May 6.5 8.8 6.3 7.3 Bank Indonesia, policy rate (%) 6.75 6.75 6.75 6.75 6.75

Singapore: Weighed down by sharp declines in output of pharmaceuticals in May and June.

India: Macro headwinds remain strong. However, favourable base effects, owing to the implementation of a new series, are likely

to support headline y/y growth.

Indonesia: With headline inflation coming down, we expect BI to stand pat this month.

Wednesday 13 July Period Prev 2 Prev 1 Latest Forecast Consensus

07:00 Korea: Unemployment rate (%) June 4.0 3.6 3.3 3.4 3.4

10:00 China: GDP (% y/y) Q2 9.6 9.8 9.7 9.4 9.3

10:00 China: Fixed asset investment (YTD, %

y/y)

June 25 25.4 25.8 25.8 25.

10:00 China: Industrial production (% y/y) June 14.8 13.4 13.3 13.2 13.1

10:00 China: Retail sales (% y/y) June 17.4 17.1 16.9 17.1 17.0

15:30 Bank of Thailand policy rate (%) 2.50 2.75 3.00 3.25 3.25

Thailand: With core inflation close to top of the target range, another rate hike is likely.

China GDP: Slowed both on a y/y and q/q basis in Q2; still on track to achieve a full-year growth of about 9%.

China: Fixed asset investment: To remain supported by the strength of property investment, with the driver shifting to the

Documents

BarCap July8 the Emerging Markets Weekly Sunshine Behind the Clouds