Market Musings
Global Rates, FX & Commodities Strategy
► GLOBAL EM
15 December 2020
► EM
2021 EM Outlook - Taking The Bull By
The Horns
•
We expect many EM economies to continue to show positive momentum in 2021
led by Asia. On aggregate, EM will recover lost output from 2020, but for many
EMs growth will not return to pre-COVID levels for a while longer.
•
Low US real rates will continue to facilitate lower policy and market rates in EM,
without leading to EM FX pressures. Improving external positions bode well for
EM resilience in 2021.
•
Asia - We expect the positive momentum in North Asia to be sustained and to
broaden out to the rest of the region in 2021. China is likely to see a more rapid
convergence to pre-COVID GDP levels.
•
EMEA - A second COVID wave is almost in full swing and may cause some
unforeseen damage. A pullback in long EMEA trades is possible in the s-t.
•
Latam - Recovery is lagging. While this will restrain sustained FX gains and
suppress interest rates through 2021, a weak USD and low US rates should
offset this impact, though Brazil remains vulnerable.
•
Policy Outlook - Benign and below target inflation, low US rates and
wide output gaps, amid likely FX appreciation pressures, to keep policy
accommodative across most of the EM spectrum. Despite significant fiscal
easing, in aggregate EM fiscal deficits are likely to widen by much less than DM
deficits.
•
Hunt for Yield - Our analysis illustrates the pressure to roll out the curve. With
global yields falling over the years, investors need to venture increasingly further
down the credit curve, and need to take on more duration risk going forward.
•
Rates trades: Long 10y INDOGB unhedged, Receive 5yr ZAR swap vs 3m
Jibar, Receive 3y RUB swap vs 3m MosPrime, Front-end G-Spread tightening
in ZAR SSAs, Long BBB-rated EM credit in USDs, Long 3yr MXN TIIE, Receive
BRL Dec21 DI.
•
FX trades:Long IDR & INR vs TWD, Long CNHTWD, Long TRY vs equally
weighted basket of ZAR & RUB, Long PLNHUF, Short ZARRUB.
► GLOBAL MARKETS
Cristian Maggio
Head of Emerging Markets
Strategy
Sacha Tihanyi
Deputy Head of Emerging
Markets Strategy
Mitul Kotecha
Senior Emerging Markets
Strategist
Izidor Flajsman
Emerging Markets
Strategist
This report is a marketing communication. It has not been prepared in accordance with legal requirements, as outlined in the UK FCA’s COBS, designed to promote the independence of investment research and is also
not subject to any prohibition of dealing ahead of the dissemination of investment research, although as a matter of policy TD Securities requires its employees not to deal ahead of the dissemination of this report.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
1
Market Musings
EM growth recovery - Growing resilience
We expect a rebound across emerging markets in 2021. Many economies showed signs of recovery over
Q3 2020 and are likely to continue to show positive momentum into next year even as second/third waves
of virus infections fuel significant risks to DM activity in the weeks ahead. Asia is likely to lead the way while
most EM economies outside of Asia are likely to record around 3-5% growth rates next year. On aggregate,
EM economies will recover lost 2020 economic growth next year but this hides the fact that growth will be
led by a few economies including China, while for many EMs growth will not return to pre-COVID levels for a
while longer. As we highlight in Box 1 the arrival of a vaccine will be another boon for emerging markets. EM
economies that are manufacturing and export orientated are more likely to experience a V-shape recovery or
where a second/third wave bite the most, a W-shape one. EMs that are more services dependent - especially
where tourism makes up a larger share of GDP - may face a longer swoosh-shape recovery, however.
At the same time, low US real rates will continue to facilitate lower policy and market rates in EM countries,
without leading to EM FX pressures. USD weakness has followed and with it, resistance by many EM central
banks, to gains in their currencies, adding to the growth in EM FX reserves, especially in Asia. Improving
external positions bodes well for EM resilience in 2021, allowing previously more vulnerable countries, with
external imbalances, to borrow more cheaply and to avoid an intensification of market pressure even as rates
are lowered and fiscal deficits widen. Our FX and rates trade ideas reflect this more positive outlook for EMs
assets.
Asia's V-shape recovery
Much of Asia, especially North Asia, has undergone a V-shape recovery, having been 'first in, first out' of the
COVID crisis. China's economy has been a linchpin for EM and North Asia in particular, with its economy well
on track to return to pre-COVID levels, helped initially by strong external demand and latterly by rebounding
domestic demand. However, it is not just China that has shown resilience. Asia's trade dependent economies
have benefited from strong exports performance throughout the COVID crisis, especially in stay-at-home
technology. Alongside China, Korea and Taiwan have been at the forefront of recovery in the region. The
strength of Chinese demand and bounce in US manufacturing activity point to robust exports performance in
the months ahead.
US manufacturing recovery likely to boost Asian
exports...
25
20
0.25
...as will Chinese imports
20
0.20
47.0
46.5
15
0.15
10
0.10
10
5
0.05
5
45.0
0
0.00
0
44.5
-5
-0.05
44.0
-10
-0.10
-5
-15
-0.15
-20
-0.20
-15
-25
-0.25
-20
15
16
17
Asia exports %, y/y, RHS
18
19
20
US ISM, y/y change
Note: Asia exports refers to average of individual Asian economies exports growth
Source: Bloomberg; TD Securities
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
%
15
46.0
45.5
43.5
-10
43.0
42.5
42.0
12
13
14
15
16
17
18
19
Asia exports %, y/y, 3m ave
China Import orders PMI (RHS, 3m ave)
Source: Bloomberg, TD Securities
2
Market Musings
North Asia managed to clamp down on COVID quickly and effectively, while South and South East Asia
lagged. This is changing, as much of the rest of the region has also got to grips with the virus. We expect
the positive momentum in North Asia to be sustained and to broaden out to the rest of the region in 2021. In
particular, we see laggards such as India, Indonesia and Philippines play catch up with their North Asia peers,
driven by domestic demand. High frequency indicators point upwards, and increasingly the demand side of
Asia's economies are catching up with the supply side. Meanwhile, imports compression, exports resilience,
and more recently a resumption of portfolio inflows, are helping to strengthen Asian balance of payments
positions, fuelling a rapid increase in FX reserves. Separately, we think a Biden presidency, and likely split
Congress, bodes well for Asia.
105
China Tertiary Sector Electricity Consumption
China Quarterly GDP By Industrial Sector
Relative to Pre-Covid Trend
120
Actual
Pre-Covid Trend
100
Bln KWH
95
80
90
GDP
Source: Haver, TD Securities
Jul-20
Sep-20
May-20
Jan-20
Mar-20
Nov-19
Jul-19
Sep-19
Jul-18
May-19
Sep-20
Jan-19
Jun-20
12000
Mar-19
Mar-20
Nov-18
Dec-19
60
Sep-18
14000
80
70
May-18
Figure xx: Insert Title Here
Services
Jan-18
Manufacturing
85
16000
x: Insert Title Here
90
Mar-18
Q4 2019 Trend GDP = 100
110
100
Source: Haver, TD Securities
China - rapid convergence back towards pre-COVID GDP levels
China's position as the first country to be hit by the virus, combined with its ability to contain the most severe
period of viral spread early, has positioned the Chinese economy for a more rapid convergence back towards
pre-COVID GDP levels. Indeed, the manufacturing sector has virtually reverted to pre-COVID trend output
levels, as it benefited from a combination of viral containment, external demand for PPE/work-from-home
products, as well as a buffering government stimulus effort.
While the growth recovery profile is of the "V" variety, the services sector is lagging behind manufacturing,
depicting an overhang that will likely continue to impede tertiary sector growth until a full vaccination program
is deployed and herd immunity is achieved. The wait for vaccine disbursement hasn't hindered retail sales
consumption, however, as levels through October have generally returned to pre-COVID levels, though mostly
for the urban consumer. Other indicators of the tertiary sector denote a slog back to full operating levels
that will continue for some months. Passenger travel levels in aggregate across various modes of transport
remain well below (at 70% of) pre-COVID levels. While electricity consumption of the industrial sector has
bounced back in line with manufacturing output indicators, services sector electricity consumption remains
about 4% below the pre-COVID trend. While these indicate a still strained service sector economy, we expect
the recovery to continue and provide upside impetus for quarterly growth moving forward.
Other EM - mixed picture
While the picture for EM economies outside Asia has not been as impressive, they have registered a
significant improvement in growth prospects due to a combination of an improving COVID picture, fiscal and
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
3
Market Musings
monetary injections, strengthening external demand and a rebound in China, helping to put a floor under
commodity prices. Latam has managed to control the spread of COVID relatively well over recent months in
contrast to EMEA where COVID cases had increased sharply but appear to have peaked in recent weeks.
Admittedly, the EMEA case is mostly driven by Eastern Europe and part of the Middle East, while Africa
(especially sub-Saharian) has mostly escaped an economically disruptive second wave. But as Africa was the
last continent to see the spread of COVID in the first wave, we cannot rule out a lagged second wave that may
weigh more on 2021 growth compared to other regions and peers.
EMEA - Recovery ongoing but beware of second and third waves
Economic recovery has been visible in high frequency indicators for months. Real GDP growth in EMEA has
mostly surprised to the upside in the third quarter, in line with most core European economies. However, while
Asia has quickly come to grips with the virus, and has mostly been capable of controlling the spread of a
second wave, most of Europe is now dealing with the insurgence of a nasty second wave that has triggered
new restrictive measures across the continent. The negative impact on regional economies will only be visible
in official numbers a few months down the road, but some early indicators such as PMIs suggest that a
pullback following post-lockdown rebounds is already materialising. Against this backdrop, it is only fair to say
that while economic data for Q3 has surprised to the upside, the closing quarter of 2020 and Q1 2021 may
have some negative surprise in store for Europe, especially for CEE countries (where Slovakia and Hungary
still show a deteriorating COVID picture, while Poland, Czech and Romania are now improving after new
lockdowns), Turkey and Russia.
This same may be true for Africa where a number of leading economies are showing early signs of COVID
spread accelerating. Among the largest continental economies, South Africa had until recently successfully
avoided the disruptive impact of a second wave, but numbers are starting to confirm that this is happening
now; Egypt and Nigeria also exhibit worrisome dynamics - we may see an intensification of the trend before
the picture improves next year. Finally, in the Middle East, COVID seems under control in terms of a second
wave. The UAE and Qatar show a stable picture at the moment, while Saudi Arabia is improving. However, as
these economies are mostly oil dependent, the accelerating recovery of Asia, and demand from its commodityhungry economies, should support local activity and improving fundamentals in the hydrocarbon exporters of
the Middle East going forward.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
4
Market Musings
A note of caution must be mentioned. In the summer months we were pointing at a strong economic rebound
in EMEA and elsewhere over Q3. We were also warning against a second COVID wave that we had expected
to strike in the fall. This has indeed materialized in several countries, with only a handful of EMEA economies
capable of avoiding it. We are now observing (and measuring the economic impact of) renewed lockdowns
and other restrictive measures, some of which are directly imposed in EMs, others indirectly impacting EMs as
core European economies like Germany revert to a full, albeit time limited, economic lockdown. We think the
second wave will be less economically damaging than the first one, but will nonetheless subtract potential from
the recovery. We also warn against a third wave following the year-end festivities and Christmas gatherings
that will likely see the pandemic remain a very material threat throughout the winter months, especially in the
Northern Hemisphere. This suggests that most EMEA economies, and some African ones, are more likely to
experience a W-shape recovery, with a shorter but somewhat elongated second leg.
40
Sentix Economic Sentiment Index: Latam
Latam Export Growth
(%Y/Y, 12mth m.a.)
50
40
20
30
20
Chile
Mexico
Brazil
10
-20
%
Index Level
0
Colombia
0
-40
-10
-20
Economic Expectations
Current Economic Situation
-60
-80
Jan-14 Dec-14 Nov-15 Oct-16 Sep-17 Aug-18
-30
Jul-19
Jun-20
Source: Haver, TD Securities
-40
Jan-14 Dec-14 Nov-15
Oct-16 Sep-17 Aug-18
Jul-19
Jun-20
Source: Haver, TD Securities
Latam - Lagging the EM Recovery
Insofar as sentiment indicators measuring the current state of economic affairs and forward expectations are
concerned, Latin America generally remains behind the other two major EM regions, albeit in sync with the
pace of improvement. This is despite the fact that the fiscal response has been highly aggressive in general
for Latam, save for the sovereign credit risk-constrained case of Mexico. While these fiscal measures have
bolstered growth in 2020, they have also set up a substantial fiscal drag during 2021. Brazil has been a
standout in this sense, at nearly 16% of GDP in deficit this year, with Colombia approaching 9% and Chile just
over that mark. Mexico has held to just under 5% of GDP, much of it reflecting contraction in overall growth
rather than substantial new or additional stimulus. Thus, for 2021 we see reason to believe that Latam will
continue to lag given the fiscal headwinds in the pipeline, with Brazil in the most precarious position, setting
up the potential for market-riling fiscal slippage. We note that Mexico's EM leading growth contraction in
2020, within the context of a minimalist approach to 2020 fiscal stimulus, does not necessarily set up growth
outperformance in 2021 simply on the back of an absence of substantial fiscal drag. Mexico's real growth
going into the COVID crisis had been for the two preceding years nearly nil, thanks in great part to stagnant
investment. With the overhang of this dynamic still present, there are no signs that economic momentum is
endogenously set to outperform other Latam nations that engaged in aggressive fiscal stimulus during 2020.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
5
Market Musings
EM economies to rebound strongly in 2021
10
140000
8
6
120000
4
100000
2
80000
%
no. of cases, 5 dma
EM trying to get a grip on Covid
160000
0
-2
60000
-4
40000
-6
20000
-8
Aug-20
Asia
Sep-20
Oct-20
Latam
Oct-20
Nov-20
Dec-20
EMEA
Source: Bloomberg, TD Securities
-10
INR
CNY
PHP
MYR
SGD
IDR
CLP
HUF
THB
COP
ILS
CZK
TRY
HKD
RON
BGN
PLN
BRL
MXN
KRW
TWD
ZAR
RUB
0
Jul-20
2021
2020
Note: Forecasts are from Bloomberg Consensus. Source: Bloomberg, TD Securities
Box 1: COVID: Moving Towards "Behavioural Immunity"
The arrival of a vaccine will be another boon for emerging markets although much will depend on how quickly
it will be distributed, given that the producers of the two most effective candidates so far, Moderna and
PfizerBioNtech, are based in developed countries. In this respect, EM economies that are more services
dependent - especially where tourism makes up a larger share of GDP - may face a longer swoosh-shape
recovery as mass vaccination becomes available at a later stage, and herd immunity is achieved 1-2 years
later than in G10. That said, some countries including China are trialing their own vaccines and/or have
ordered from other producers.
Emerging markets have been less aggressive in securing vaccines though the COVAX partnership is
attempting to ensure more equitable distribution. Indeed the COVAX programme is working to source access
to COVID vaccines for all parts of the world; this will especially help distribution in EM countries. Among EMs,
India has been the most aggressive followed by Indonesia, Brazil and the rest of Latam. The likes of India
and Brazil have used access to their large manufacturing capabilities to secure higher doses while India is
also moving ahead with its own vaccine development. The biggest advance orders are for the AstraZeneca/
Oxford Uni vaccine (India 500k, Indonesia and Brazil 100k). However, many EMs have only limited orders for
vaccines at present. We think the relatively low cost of the AstraZeneca/Oxford vaccine and easier storage and
transportation will mean that this vaccine could be crucial for EMs.
EMs mostly undershooting inflation targets
Many EMs have struggled with the inflationary impacts of COVID-related supply disruptions but as these
have dissipated amid easing social distancing requirements, food prices have softened. Demand side
price pressures have been particularly weak, especially in non-essential and travel/tourism sectors. While
aggregate demand is likely to pick up in the months ahead, there is still a significant amount of slack across
EM economies, implying the persistence of limited price pressures in the months ahead.
There are notable exceptions (Turkey and India), but for the most part EMs have undershot inflation targets
this year, some by a long way (Thailand, Indonesia, Korea). While the magnitude of undershooting is likely
to narrow, we do not expect EM inflation pressures to intensify significantly in the months ahead. A potential
risk to EM inflation could be a sharp increase in inflation expectations, brought about by EM central banks
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
6
Market Musings
extending their asset purchases programs longer than required. However, presently, there are few signs that
such asset purchases have led to an increase in inflation expectations.
Mexico and Brazil constitute cases of weak domestic demand pressures playing against temporary upside
shocks to inflation directly from COVID (Mexico) or through an expansion in the FX fiscal risk premium (Brazil).
This has restrained further monetary or fiscal support given the potential for second round effects to add a
stagnationary shock to the complex economic situation. We expect Mexico to potentially have space for further
easing in 2021, however Brazil is at the limits of monetary and fiscal support.
Monetary policy - Staying accommodative
Emerging markets have also been aggressive in their monetary policy responses. All key emerging market
countries have eased policy this year, and some have embarked on quantitative easing/asset purchases to
help inject liquidity and help bond market functioning at a time when conventional policy was becoming less
effective. EM Central banks have also been active in terms of FX intervention and credit easing. The results
have been positive for the most part, with financial conditions easing across the EM spectrum. Rate cuts have
been particularly aggressive in Mexico, South Africa, Russia and Brazil while on the other end of the spectrum,
China's economic resilience has limited the extent of easing there. Some countries such as India have been
more constrained due to food price pressures caused by supply side restrictions. Turkey is also a notable
exception having cut and hiked rates already, with a net tightening effect overall in 2020, but overall policy is far
looser across EM.
In 2021, we do not expect a rapid reversal in policy direction, with benign and below target inflation, low US
rates and wide output gaps, amid likely FX appreciation pressures, to keep policy accommodative across
most of the EM spectrum. That said, we think further EM easing is limited from here. Several major EM central
banks note that their policy settings are already accommodative, implicitly recognizing the need to normalize
(i.e. push rates higher) at some point in the future. Therefore, we expect only further, albeit limited, easing in
India, Indonesia and Hungary, while we expect Turkey to continue to tighten policy in early 2021, and ease
later next year if the attempts to stabilize the currency have succeeded. Later in 2021/early 2022 we expect
to see a number of EM central banks embark on gradual tightening. But risks are skewed to the downside as
later/smaller tightening than we forecast is marginally more likely than earlier/larger tightening than anticipated.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
7
Market Musings
4
%
2
0
-2
-4
ILS
THB
IDR
BRL
KRW
ZAR
PHP
RUB
PEN
COP
CLP
CNY
HUF
RON
INR
MXN
PLN
CZK
TRY
-6
% Deviation from target (2020 Consensus forecast)
% Deviation from target (Current CPI inflation)
4.0
Almost all EMs except notably Turkey, sharply cut
policy rates in 2020
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
TRY
BGN
ILS
TWD
HUF
CNY
KRW
THB
RON
INR
CLP
IDR
MYR
SGD
PLN
CZK
HKD
RUB
PEN
PHP
COP
BRL
ZAR
MXN
6
% Change (Current vs. Beginning of 2020)
Mixed picture, but many EMs undershoot CPI targets
8
Source: Bloomberg, TD Securities. Note: Interest rates for SGD and CNY is derived from 3m SIBOR
Source: Bloomberg, TD Securities
Fiscal Policy - Less room for manoeuvre
Emerging markets have had less fiscal room for manoeuvre than developed markets. Despite significant fiscal
easing, EM fiscal deficits in aggregate are still likely to widen less than DM deficits. South Africa is likely to
see the biggest deficit increase among major EM countries - we expect a deficit of around 17% of GDP in
2020, followed by another double-digit deficit in 2021. Brazil also stands out with a likely deficit of 16% in 2020,
followed by 6.7% in 2021. Other EMs where we anticipate deficits in excess of 7% of GDP - large relative to
the EM average - are Poland, Hungary, Turkey and India this year.
0
EM fiscal deficits blow out in 2020, likely to narrow
next year
EM general government debt increases less sharply than
DM debt
140
-4
Advanced
economies
120
-6
100
-8
% of GDP
Fiscal Deficit (% of GDP)
-2
-10
-12
-14
-16
80
60
40
2020e
2021f
Malaysia
Indonesia
India
China
S Africa
Turkey
Russia
Hungary
Poland
Mexico
Brazil
-18
2022f
Source: Bloomberg, TD Securities
Emerging
market
economies
20
0
30
40
50
60
ADV (PPPGDP)
70
80
90
00
10
20
EM (PPPGDP)
Source: IMF, Historical Public Debt Database; IMF, World Economic Outlook database;
Maddison Database Project; and IMF staff calculations.
Weak demand for EM local currency debt earlier in the COVID crisis restricted the ability to boost spending at
a time when revenues were shrinking. However, this was mitigated in part by outright central bank purchases
of government debt (Indonesia, Philippines, Poland, Hungary, Turkey, South Africa) and in some cases such
as Singapore, funding came from FX reserves directly or extrabudgetary funds (India) /sovereign wealth funds.
Despite the smaller size of EM fiscal injections, fiscal/debt risk will increase substantially and EMs could be
prone to spikes in interest rates, weaker FX and/or extended economic weakness.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
8
Market Musings
Unconvential policy approaches
China's unique combination
China's actions to address the COVID shock have been a combination of pure monetary measures (rate
cuts, abundant liquidity provision) and those of a pseudo-fiscal nature. The latter is best summarized by the
temporary suspension of the macro deleveraging agenda. Indeed, in 2020, Chinese stimulus efforts have
focused on ensuing an abundance of financing, which has to some degree rehashed the debt-stimulus efforts
of the past, albeit with a shift in the tool mixture.
Chinese Total Social Financing Components
50%
RMB Bank Loan
Corp Bond
Gov Bond
Overall TSF
45%
40%
% of GDP
35%
30%
25%
20%
15%
10%
5%
2019
2020F
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
0%
Source: Haver, TD Securities
Total social financing, as a percent of GDP, is set to reach levels not seen since the GFC. While the strong
policy response bears some resemblance to the 2009 GFC stimulus effort, in terms of the prominence of debt
financing, the makeup has shifted. Whereas bank loans had in the past constituted the lion's share of stimulus,
the mixture now includes a greater proportional emphasis on local government debt, a newer post-2016 tool
in the policy toolbox. This has to some degree taken the place of shadow banking-based funding, bringing
onto the government's balance sheet local government debt financing, thus placing greater policy control over
this component of financing's size and use. Lower interest rates have also helped generate greater corporate
bond issuance, leading the overall pure debt component of financing to resemble 2009 levels. While the
intensity of RMB bank loan disbursement in 2020 is substantial in a historical context (the largest since 2009),
local government bond issuance has been a greater contributor to the overall "delta" on policy-directed debt
financing.
The question remains, ahead of the crucial December Economic Work Conference, what lies ahead for 2021?
Given expectations on vaccine disbursement both in China and globally, it is highly unlikely that we see the
debt financing impulse repeat 2020 levels. The simple benchmark of previous post-crisis dynamics suggest a
smaller impulse, more in line with that of recent years, particularly given our view that a post-COVID focus on
macro deleveraging and the quality of growth (over quantity) will return. Indeed, Chinese policymakers held
the line on debt stimulus conservatism through the substantial 2019 manufacturing sector slowdown, and it
is likely that as the COVID crisis ebbs, we see a reversion to the mean. We have already seen a degree of
monetary neutrality return following PBoC normalization of short term interbank rates during the second half of
the year, with levels now in line with the pre-COVID period. Technocrats at the central bank are likely to focus
on risks associated with macro leverage and debt, particularly with bond defaults by SOEs recently taking
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
9
Market Musings
greater prominence in news headlines. However, we do not expect official policy rate normalization in 2021, as
the economy will remain in recovery mode.
In emerging markets outside of China, four central banks stand out as being the most aggressive in terms of
unconventional policy responses, namely Philippines, Indonesia, Poland, and Turkey.
•
Phillipines: Aside from 200bp of policy rate cuts, the central bank, BSP has purchased substantial
amounts of government securities. BSP agreed to debt purchases of around PHP 540bn directly from the
government in October 2020, stopping short of completely financing the government's fiscal deficit. BSP
has also purchased substantial amounts of government debt in the secondary market, with both primary
and secondary purchases amounting to a total of around 6% of GDP. We don't expect the BSP to phase out
such purchases anytime soon, with such policy likely to extend well into 2021.
•
Indonesia: Bank Indonesia cut policy rates by 125bps over 2020, while implementing liquidity measures
too. However, the biggest steps were allowing BI to purchase government bonds in the primary market and
the 'burden sharing' agreement with the government to finance the government fiscal response to Covid-19.
There has been some concern about the independence of the central bank but officials have denied any
steps to reduce its independence. There have also been concerns on the duration of deficit financing burden
sharing, with more actions likely in 2021. Markets may become wary if this policy persists for an overly long
period.
•
Poland: The NBP cut policy rates by 140bps in Q1 of 2020 and launched the largest QE program in EMEA.
Eligible securities are being bought only in the secondary market. The total amount of bonds purchased is
PLN105bn or around 4.5% of GDP, at the time of writing. Overall, QE can continue and eventually expand
to around 10% of GDP. Initial concerns about transparency of the Polish QE program, its size, and how long
it can be sustained for before it weighs on the zloty have progressively eased. Poland's sizeable current
account surplus, which is here to stay in 2021 and has contributed to the zloty's appreciation, makes us
believe that QE will extend well into 2021.
•
Turkey: The CBRT has used a full array of measures to support credit growth and economic activity in the
first COVID wave. This includes conventional rate cuts, as well as tweaks to reserve ratios, use of the assetratio rule to boost bank lending, and QE. The macrofinancial imbalances these new measures introduced
stacked up with Turkey's prior imbalances. Overly-expansionary monetary policy combined with fiscal laxity
to produce faster inflation and a weaker lira throughout 2020. As inflation proved insensitive even to the
demand-side shock caused by the lockdown, the CBRT started to tighten policy by stealth in July. The CBRT
Governor was eventually replaced in November in order to foster a return to orthodoxy while driving interest
rates higher. Overall, Turkey has delivered more tightening than easing this year, and further rate hikes are
likely in the coming months, starting with the Dec MPC meeting.
Exit Strategies - Threat lies more heavily with monetary policy
As noted above, the typical fiscal response to the crisis in most emerging economies was significantly smaller
compared to DMs; the IMF estimates that advanced economies responded to the pandemic with fiscal stimulus
worth roughly 9.2% of GDP, compared to just 3.4% in emerging markets. This necessarily left monetary
authorities to do more of the heavy lifting, which in turn implies that in the EM space the threat of early exit lies
more heavily with monetary policy.
We expect the majority of EMs to prep for tighter policy into the end of 2021, and the vast majority to have
delivered some form of tightening by early 2022. In a few circumstances, rate hikes and/or a tapering of QE
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
10
Market Musings
may occur sooner, as is the case of Turkey where tightening already started in July 2020. Currencies that have
experienced significant depreciation will see central banks most at risk of early and more rapid tightening,
with the TRY and BRL both down in excess of 20% this year versus the USD and the RUB not much better at
-15%. Admittedly, all three currencies have been recovering over the past few weeks. Turkey, in particular, has
already lifted rates materially, with the one-week repo rate jumping 475 bps in November (though this was met
only by a modest increase of the WACF). Other central banks from countries with struggling currencies may
follow suit in the urge to normalize policy.
Fiscal/monetary policy tensions - Risks of a backlash
Blurring the lines between fiscal and monetary policy
Policy tensions are easy to envision in the near- to medium-term in the emerging market world where capital
flows tend to be especially prone to swings, and political institutions and policymakers have typically not
established as much credibility as the advanced economies. In many EMs, the lines between fiscal and
monetary policy have blurred. Low inflation, with a few notable exceptions (Brazil, Turkey and India), and
significant USD liquidity via swap lines and repo facilities, have helped to dampen spillovers to local bond
markets and FX. Should inflation push higher as growth recovers, and given the increased foreign participation
in many EM local currency bond markets, EMs could face a major backlash. In this respect, Turkey is the
perfect template of an economy where policies have been too focused on growth for too long, causing
overheating and high inflation even when demand-side weakness should drive the price dynamic in a benign
direction.
Inflation is the key
As it is, a massive increase in bond supply amid widening fiscal deficits has been met with sharply higher
central bank purchases (Indonesia, Philippines and Poland in particular), alongside reliance on domestic
bank buying, of LC bonds (especially in Turkey). Such purchases have had the desired effect via lower
long-term yields. However, if investors get a whiff that such policies are here to stay, fears over central
bank independence (for example, evidenced in Indonesia over recent months, and in Turkey for years) and
credibility concerns (Turkey), could provoke a bond and FX market revolt. Inflation is the key here; it is no
surprise that the RBI in India amid a spike in inflation over recent months, has been reluctant to monetise
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
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Market Musings
debt, and instead conducts policy via its own approach to Operation Twist. Turkey has dealt with high inflation
tightening by stealth but has remained constantly behind the curve, imposing collateral measures to try to
(unsuccessfully) control the currency via a massive buildup in swaps that has eventually eroded FX reserves to
below zero.
Beware of fiscal dominance
If EM central banks go back to being a tool of government policy and fiscal dominance becomes the norm, any
fledgling improvement in credibility would evaporate quickly (once again, the Turkey example is to be looked
at closely). The backlash would be felt via higher risk premiums/steeper curves in local currency bonds and
depreciation pressure in FX markets. We see particular risks in countries where central banks have sharply
stepped up purchases of LC bonds, including in Poland, South Africa, Indonesia, and Hungary and where
local banks have increased their purchases, adding Brazil and Mexico to the list. China has been immunized
to a large extent due to strengthening economic performance as well as non-free capital flows. However,
accelerating foreign private sector participation (relative to central bank holdings) in China's bond markets amid
relatively higher yields, raises the risks of increased domestic market volatility in the event of a reversal.
Treading a tightrope
Going forward, EM policymakers will increasingly be treading a tightrope between fiscal and monetary policy.
While low US rates and a weak USD amid negative output gaps, will allow a lower for longer stance, many
will not want to rock the boat by easing too aggressively on the monetary policy front or on the fiscal front
given concerns about fiscal slippage and the growing inter-linkages between fiscal/monetary. Foreign investors
are finally returning to EM local currency debt markets, but governments will not want to overplay their
hands. Increases in fiscal deficits and debt levels will only raise the vulnerability of EMs to further economic
hemorrhaging or FX depreciation risks. As such, EM central banks and governments are likely to take a
cautious stance, with most already close to the bottom of their monetary and fiscal easing cycles.
Hunt for Yield in EM
There are numerous opportunities for investors to be grabbed in EMs. To pick up additional yield, moving into
EM products has almost become a necessity. High-grade SSA bonds denominated in EM currencies (simply
named EM SSAs from here on), and EM USD-denominated sovereign and corporate bonds from investment
grade (IG) issuers offer good examples. We are particularly interested in the historical spread of these EM
products over DM. We reduce dimensionality of the analysis by focusing on 5Y maturity bonds that we swap
into 3m USD Libor (we initially developed this analysis, in our Global Outlook 2021, for CDOR).
EM USD bonds: We find that investors looking for yield enhancement but not for more risk complexity (such
as adding an undesired FX risk dimension) can maximize their yield pickup by investing into EM IG USD
bonds. These products offer the highest yield pickup we can currently observe in IG credit. In fact, for an USD
IG investor, an EM $ credit can offer the return of a USD name with 2-3 notches more of credit risk. We also
note that such pickup is, in certain cases, still wider compared to pre-COVID levels. On the contrary, DM localcurrency (LC) SSA products currently trade tighter than levels prior to March 2020. Among the products we
have analyzed, EM HC corporate bonds offer the highest pickup.
EM LC bonds: The last decade shows that high-grade EM SSAs did not always perform well in providing
yield enhancement when swapped into a G10 reference currency. This comes in contrast with DM SSAs that
have historically performed better. However, PLN spreads illustrate why EM SSAs should not be neglected. At
times, PLN SSAs do offer - albeit on a temporary basis - some sizable pickup over SSAs denominated in USD,
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
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Market Musings
CAD and EUR. This is not the case currently, however. In fact, none of the EM currencies that have historically
offered better swap margins currently stands out vis-à-vis DM SSAs (see RHS chart below).
5Y Xccy Swap Spread Over 3m LIBOR
CAD
USD
EUR
HC Sovn AA
IG Spread Product Pick-up Over 3m LIBOR
180
120
120
160
100
100
140
80
40
80
20
60
0
0
Nov-18
Mar-19
Jul-19
Source: Bloomberg, TD Securities
Nov-19
Mar-20
Jul-20
Nov-20
ZAR
CAD
EUR
60
20
EUR
AUD
USD
CAD
NZD
SEK
NOK
PLN
MXN
ZAR
AA
A
BBB
AAA
A
BBB
A
BBB
A
BBB
A
BBB
20
MXN
40
-20
40
PLN
80
60
Bps
Bps
140
100
5Y Xccy Swap Spread Over 3m LIBOR
140
200
120
Bps
160
160
HC Corp AA
SSA
SSA
DM
EM LC
Source:Bloomberg, TD Securities
Corp
Sovn
EM HC
CA
EU
Credit
US
0
-20
-40
Jan-10
Jan-12
Jan-14
Jan-16
Jan-18
Jan-20
Source: Bloomberg, TD Securities
Optimal Allocation for Rates Portfolios
The asset price recovery this year has been particularly swift, thanks to central banks and other policy
interventions. But what if regulators had not stepped in? We would probably be commenting on a trichotomy
characterized by:
1. Assets that recovered quickly: Mostly G10, S&P and best quality EM bonds.
2. Assets still recovering that remain below pre-COVID prices: Most G10 stocks, select HY, EM
sovereign bonds and some credit, select EM stocks and currencies.
3. Assets that will take a significantly longer time to recover: HY, most EM stocks, lower quality EM
bonds and EM FX.
While these three asset groups exist in all market conditions, we have observed a prevalence of the first two
types of assets thus far in 2020, even for riskier investments.
In order to deal with investment uncertainty and avoid the risk of being overly positioned in the second or
third group, we look to define a well-balanced portfolio for the short-to-medium-term. We have focused on FI
products alone, analyzing well over 40 indices that track the performance of SSA and sovereign bonds from
both G10 and EM issuers, as well as USD, EUR, Canadian, and EM credit. We have excluded G10 sovereigns
to focus solely on spread products, and only use USD-denominated EM bonds for the scope of this analysis
(this suggests we bear credit risk but no currency risk for a USD investor), while the EM LC component is
covered through EM SSA bonds (the currency risk is partly offset by minimal credit risk).
We generate two stylized portfolios, one averaging 3y and another with 5y in maturity. We run these portfolios
through a Markowitz optimizer while making some changes to the standard procedure. For example, rather
than optimizing total returns for risk (vol), we have swapped all assets into a 3-month floating rate in order to
provide a homogenous measure of spread over benchmark. This can be used as a proxy of future total returns.
This methodology also allows us to normalize for risks. By swapping into USD LIBOR for the examples here,
we are removing currency, duration and credit risk (though we are introducing counterparty risk, as a result of
the swaps) given all results are reported as margin over a floating rate in one reference currency. Since our
target variable is a spread measured in basis points, its measure of volatility will also be measured in basis
points. ('Volatility of spread' identifies the standard deviation of spreads - with the mean calculated over a
period of five years - for each group of bonds).
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
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Market Musings
Our basic basket uses 3m USD LIBOR as the example here. However, results in other Libor rates, such as
GBP Libor or Euribor, can be proxied by adding a constant (our original analysis vs 3m CDOR can be found
here). This makes the conclusions for USD Libor swaps a valid benchmark for other markets. Finally, we have
excluded 10y bonds from the analysis because we lack a comprehensive set of EM assets with long-horizon
generic maturities. However, for the reader who may want to adjust the analysis to include longer-dated bonds,
our conclusions are still likely to hold – 10y bonds will simply add another layer of spread vs vol whereby both
are expected to be higher compared to the 5y and 3y groups.
The chart above on the left shows the analysis on the 5yr-maturity basket. It is interesting to note that, for a
USD investor who has the freedom to invest in any of the assets reported above, the vast majority of spreadover-Libor vs vol pairs can be achieved combining different assets together. There are a few situations where
the optimization procedure suggests concentration (which we would always discard as an optimal selection
of assets regardless). One extreme case is the basket that achieves the maximum spread possible (171bps)
at the cost of maximum vol (56bps) suggesting 100% allocation in EM $ BBB-rated corporate bonds. On the
opposite end of the spectrum, the optimal basket that achieves the minimum volatility possible (spread 9bps,
vol 6bps) is made of 58% AUD SSAs, 8% USD SSAs14% and 34% NZD SSAs. Another interesting example is
a basket that achieves the maximum Sharpe ratio (spread 58bps, vol 13bps) suggesting 59% in EM AA-rated
credit, 37% in NZD SSAs and 4% in USD BBB credit (see RHS chart above).
The above analysis is the result of unconstrained optimization, meaning we do not set limits to weights that
each asset class can be allocated. A better solution would mix risk and vol, setting minimum and maximum
weights in a portfolio, such that it may allow the achievement of the optimal combination of spread vs expected
vol.
The one interesting takeaway from this analysis is that only nine of the 21 asset classes used in the 5yr basket
are returned in the optimal basket for any given level of vol – these are SSAs issued in AUD, USD, NZD and
MXN; AA-to-BBB rated EM corporates in USD; and US A-rated and BBB-rated credit.
Beyond this, the optimization exercise also clearly illustrates the pressure to roll out the curve. With global
yields falling over the years, investors need to venture increasingly further down the credit curve to obtain
the same returns they did in the past while taking less risk. For example, a 100bps spread over Libor in the
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
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Market Musings
2010-2015 period was achievable with a vol of approximately 10bps, while it now requires almost three times
as much vol. This can be seen in the chart above on the left comparing the old efficient frontier (yellow dotted
line for the 2010-2015 period) with the new one (green dotted line for the 2015-2020 period).
During the former period, the basket of optimal assets would have mostly been made of G10 products, while
nowadays it requires a substantial portion of EM bonds, as well. Finally, in 2010-2015, the lion's share of the
EM allocation would be tilted to sovereign bonds in USD and BBB-rated EM and CAD corps to boost vol in
order to achieve the highest possible spreads. Nowadays, EM sovereigns and CAD corporates have not even
been included in the optimal basket as better combinations of spreads vs vol can be achieved by mixing US
BBB credit with the full array of EM corporate bonds, phasing out the higher rated (AA) for the single-A rated
and the BBBs when higher spreads are targeted.
Extending the analysis to the 3yr space, the conclusions are similar. Shorter maturities contain vol at lower
levels but also achieve lower spreads, generally speaking. The temporal drift in optimal allocations reflects
changes we have also observed in the 5yr basket. This tells us that we also need to reach further down the risk
curve in the shorter-maturity basket in order to earn spreads comparable with past periods of time. We also
highlight that this basket has almost no EM presence as the generic 3yr maturities are not always available.
The one relevant difference is that the achievable frontier for shorter dated bonds has contracted. We can no
longer earn the same spreads that were achievable in the previous five-year period. This is clearly a function
of falling yields in developed markets, associated with the ZIRP and NIRP frameworks that have gained
prominence in an increasingly larger number of markets.
Therefore, a second important conclusion is that, in order to aim at higher potential returns, not only do FI
investors need to accept greater credit risk, but they will also need to take on more duration risk going forward.
Finally, we have aggregated the 5yr and 3yr baskets into one that offers broad diversification in terms of credit
risk and duration. It is worth recalling that as we swap everything to USD Libor, duration risk is eliminated. The
cost of hedging this risk is embedded in the margin that can be obtained through Xccy and ASW spreads.
The result is ultimately very similar to what could have been achieved working on a 5yr only or 3yr only basket.
The optimization procedures still cherry picks the best asset classes in terms of spread vs vol pairs.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
15
Market Musings
Many assets in our simulation are not deemed essential to achieve the higher potential returns. However, the
optimal basket contains SSA and corporate assets from the G10 space, both 3y and 5y maturities, along with
both EM sovereign and corporate bonds. For instance, a spread target of approximately 99bps (which can be
achieved with minimum volatility of 10bps) would see a portfolio built with 5yr PLN SSA, 5yr EM BBB-rated $
corporate and sovereign bonds, 5y and 3y Canadian BBB-rated corporates, and 3y EUR-denominated BBB
corporates. The overall basket would be split 12% EM and 88% DM, still overwhelmingly skewed towards
the latter (see table below). However, the suggested allocations to EM bonds are likely higher than what a
standard global portfolio would typically include.
Bottom line: future performance is not guaranteed. However, if portfolio managers want to achieve spreads
comparable to what they used to, they will have to tolerate higher vol and modify their portfolios in order to
extend duration and grow allocations to riskier asset classes such as EM and high yield credit.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
16
Market Musings
Market Implications/Trades
Trades
EM Trading Biases for 2021
Asia
Rates
FX
Long 10y INDOGB unhedged
Long IDR & INR vs TWD (High-yielders vs Low-yielders)
Long CNHTWD
EMEA
Receive 5yr ZAR swap vs 3m Jibar
Long TRY vs equally weighted basket of ZAR & RUB
Receive 3y RUB swap vs 3m MosPrime
Long PLNHUF
Front-end G-Spread tightening in ZAR SSAs
Short ZARRUB
Long BBB-rated EM credit in USDs
Latam
Long 3yr MXN TIIE
Receive BRL Dec21 DI
Source: TD Securities views as of 15 December, 2020
EM assets registering a solid end to 2020
120
Investor positioning (HF) in EM assets increases
sharply
1.00
0.95
Correlation coefficient
115
110
105
100
95
Feb Mar Apr May Jun
EM USD agg
EM LC Gov (hedged)
EM FX
Jul
Aug
0.75
0.70
0.65
0.55
Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20
EM LC Gov (unhedged)
EM FX
FX Vol adjusted EM LC excess yields show most
EM bonds are attractive
0.35
0.30
0.80
0.25
0.60
0.20
0.40
0.15
0.20
0.10
0.00
0.05
Global Rates, FX & Commodities Strategy 15 December 2020
CNY
SGD
THB
MYR
PLN
MXN
RUB
KRW
PHP
INR
HUF
IDR
CZK
TWD
PLN
SGD
THB
KRW
BRL
HUF
1y ago
Note: Risk measured by 12m implied volatiltiy. Carry measures by 12m rates.
Source: Bloomberg; TD Securities
-0.15
BRL
Current
MYR
ZAR
PHP
RUB
IDR
-0.10
MXN
-0.60
INR
-0.05
CNY
0.00
-0.40
TRY
-0.20
TD Securities
EM Equities
Note: Based on two year rolling correlations of monthly changes in HF performance and
underlying assets. Source: Bloomberg, TD Securities
Many EM currencies attractive on a carry and risk
adjusted basis
1.00
0.80
0.60
Sep Oct Nov Dec
EM LC Gov (unhedged)
EM Equities
Note: Rebased to 100 at 24 Jan 20. Source: Bloomberg, TD Securities
1.20
0.85
ZAR
Jan
0.90
Note: EM Bond excess yield calculated by taking a 20d average of country excess yields (10y).
We subtract UST yields and hedge costs (5dma) to arrive at the excess yield.
Source: Bloomberg, TD Securities
17
Market Musings
Asia
Overview - Asian assets have registered a solid performance over recent months, outperforming other EM
regions. Asian equities in particular have strengthened, though gains in Asian assets have been broad based
amid a rebound in portfolio capital inflows. Given the relatively favourable economic backdrop discussed
earlier, we see little for this picture to change in 2021. Likely wider vaccine distribution, global economic
strengthening and USD weakness, are likely to continue to buoy Asian assets. Resistance to FX gains is likely
to intensify however, pointing to less rapid Asian FX appreciation in the months ahead. We see plenty of scope
for portfolio capital flows to Asia to reverse the sharp outflows registered over much of 2020. Asset market
gains have been led by North and NE Asia over 2020. We expect the market laggards of 2020 to play catch up
as domestic demand driven economies such as India, Indonesia and Philippines, register improvement.
FX - Asian currencies have been led by CNH over 2020 (total returns), with other North and North East Asian
currencies including KRW and TWD not far behind. INR and IDR have lagged along with THB. As we wrote
in A Bullish Case for Asian Currencies (October 20), aside from USD weakness, Asian FX will benefit from
an improvement in balance of payments, which will provide much stronger buffers to any FX pressure in the
months ahead. We expect Asian currencies to continue to strengthen in the months ahead, helped by ongoing
USD weakness; the most sensitive to USD weakness are SGD, IDR and KRW. We think China's overall policy
stance and macro agenda will continue to underpin a constructive CNY environment in 2021. As such, we
maintain our long CNHTWD trade idea. We are less constructive on INR in spot terms largely due to RBI
intervention, but expect carry adjusted returns to remain positive. We suggest a basket of long IDR & INR
(equal weighted) vs. TWD, which we think will remain an attractive funding currency.
Strong rebound in Asian equities, LC bonds & FX to
see more gains
130
120
110
100
90
80
70
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Asia USD agg
Asia LC Gov (unhedged)
Asia Equities
Asia FX
Dec
Note: Rebased to 100 at 1 Jan 20. Source: Bloomberg, TD Securities
% deviation from long term average REER
Local rates - On a vol adjusted basis we think the excess yield offered by IDR and INR local currency bonds
look most attractive while on the other end of the spectrum THB, SGD and CNY bonds look least attractive. In
China, while longer term bond yields may drift higher, the shorter end will remain anchored by the PBoC in H1.
In India we expect ongoing flush liquidity to keep money market rates under downward pressure. However, we
think swap rates have reached a floor, with the 1y NDOIS likely finding support around 3.5%. 10y bond yields
are likely to continue to be capped by RBI OMOs and benefit from continued domestic bank buying. We expect
yields to edge lower, but it will take a sustained drop in inflation to prompt a sharper decline in nominal yields.
In Indonesia, likely further strengthening in IDR will be self reinforcing, in turn driving foreign bond inflows.
10y yields are likely to head below the lows around 6.085% reached in Jan 2018 and as such we suggest
implementing long 10y INDOGB positions.
Asia FX valuations (exc China)
20
15
10
5
0
-5
-10
-15
-20
96
98
00
02
04
Asia (average)
06
08
10
12
14
+2 SD
16
18
20
-2 SD
Source: Bloomberg, TD Securities
CNY
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
18
Market Musings
Latam
Overview - For Latam the drivers of returns will be based on overall risk sentiment for EM, though, for
specific countries, then differentiated through yield and valuation arguments, within the context of growth
and fiscal risk dynamics. It is not necessarily the case that relatively lower growth will restrain FX or rates
attractiveness, so long as yield and valuation supports an investment case, within the context of fiscal risk
premia. Equity valuations have generally rebounded, though lag all-country global aggregates, while Chile and
to some degree Mexico have lagged Brazil and Colombia. Thus, the scope for idiosyncratic valuation gains on
"undervaluation" is now somewhat restrained, and estimates of equity flows through November suggest that
the COVID shock-driven outflows in February and (particularly) March have returned and leave Latam portfolio
equity flows larger in aggregate than in 2019.
FX - The generally soft USD outlook makes it difficult to position against Latam FX, particularly given the
surprisingly weak REER levels that have persisted through the end of October. The still low level of the
REERs, even in light of the late 2020 FX rally against the USD, will support the balance of payments, which
have adjusted (save for Colombia) thanks to still very weak domestic demand conditions. MXN remains an
attractive currency, less so on pure REER levels, but certainly within the context of still quite high relative yield.
COP and CLP have benefited from a rebound in commodity prices, particularly CLP thanks to copper, which
has experienced an enormous post-Q1 rally. From that perspective COP perhaps holds greater attraction
from a relatively more constructive outlook for oil in 2021 compared to copper, from current levels (see: 2021
Commodities Outlook). However, COP is not an obvious long as modest crude oil upside is likely not enough
to counter the substantial challenges to Colombia's balance of payments. The country still suffers from a large
current account deficit, despite the weak growth dynamics of 2020. We remain neutral-to-bearish on (from
current levels) BRL, considering the fiscal risk premium evident in the rates market not being sufficiently priced
into FX in our view, particularly with USDBRL trading just above the 5.00 mark. For this to be justified, the fiscal
trajectory for Brazil must evolve perfectly in 2021, which will be difficult.
Local rates - We continue to look favourably on MXN rates on the back of an assumption that further easing is
well-possible, once the central bank can confirm that the post-COVID inflation spike is truly fading, and inflation
expectations remain anchored. We don't expect substantial further easing however, and foresee 25bps-50bps
more, due to base effects that will bolster Mexican CPI in H1 of 2021, slowing the convergence back to target
in Mexican inflation. Nevertheless, we see receiving 4yr TIIE as providing attractive carry and roll (30bps),
along with the upside potential of further cuts. Brazil presents a tricky rates situation, but an opportunity if the
fiscal anchor is respected in 2021. The market has priced-in an assumption of a forced tightening trajectory,
which is logical given the fiscal risks and pass-through of inflation from FX depreciation within the context of
what are essentially record low rates. We take a more optimistic view currently, and though risk is high, we
think that receiving 1yr BRL rates remains attractive. With 275bps priced-in to year-end 2021 we think that
inflation and growth dynamics will be inconsistent with this amount of tightening. Furthermore, should the BCB
be forced to hike due to FX weakness on the back of fiscal slippage, we see 200bps being sufficient to stabilize
BRL, and hikes front-end loaded in H1. In this sense we don't think market pricing is structured in line with how
the BCB would likely respond in the face of a fiscal "blow-up". We are more likely to see 200bps of tightening
executed in 2-3 policy meetings, rather than a gradual 25bp or 50bps per meeting tightening trajectory. The
risk to receiving 1yr DI, in the case of a fiscal blow up, however would be a panicked move higher across the
entire curve, which would pressure the position.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
19
Market Musings
EMEA
Overview - EMEA assets were some of the biggest losers in the early stage of COVID. The tide has turned
since the summer months, however, with currencies such as the RUB, ZAR and, more recently, TRY posting
relevant gains. The EMEA rebound in Q3 has surprised and helped extend longs or reduced short positions. At
the same time, the Biden administration should help improve the prospects for global trade, a positive that the
market has partly discounted in November. But Biden's presidency may also pose a risk for countries with longstanding political issues (Turkey and Russia above all). The risk of a US/EU one-two on non-compliant EM
governments can result in unforeseen EM FX weakness and central bank action. For EMEA, Brexit remains
a moderate risk, while the recent agreement on the EU's Recovery Fund and the MFF has more profound
implications and will especially support CEE economies and their assets. Such prospects would be quite
positive had a second COVID wave not materialized in EMEA. New restrictive measures may bode negatively
for EMEA equities and FX in the short term.
FX - EMEA currencies could strengthen further under supportive conditions in 2021, but risks of a pullback
related to COVID are increasing. In addition, TRY and RUB are exposed to idiosyncratic sanction risks, while
the rand remains stronger than fundamentals suggest. Low yields (both in nominal and real terms) at the
front-end of the South African curve, and public issuance crowding out the mid-long end of the curve should
discourage further ZAR appreciation. We hold a mildly negative view on ZAR for 2021 under the assumption
that debt-sustainability issues may soon become a broadly discussed topic, while strong risk appetite can
continue to support it. In Turkey, radical changes in key policy seats (CBRT, FinMin) have led to an initial
positive reaction, but TRY now seems to have lost momentum. If policymakers can support the lira via further
rate hikes and adequate policies, TRY may still settle around 7.50/7.60 vs USD in 2021 and outperform highyielding peers ZAR and RUB. Sanctions are a risk not to be neglected, however, so we prefer to express a
constructive but tactical view via a long TRY position against an equally weighted basket of RUB and ZAR, but
we remain skeptical that lira can perform vs USD over the long term. In CEE, we think there is further space
for HUF to underperform regional peers (PLN and CZK), with the current account deficit being HUF's main
weakness. Furthermore, the NBH will try to take advantage of any forint rally and ease monetary policy. On
the contrary, the zloty should be supported by a strong BoP and the economic rebound of 2021, with some
negative offset from an overly expansionary monetary policy. Overall, we expect the zloty to stay flat vs USD,
but weaken slightly vs EUR. We like to express our view via a long PLNHUF position targeting a move to 84.
Alternatively we see merits in long CZKHUF positions.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
20
Market Musings
Local rates - EMEA economies are recovering, but monetary conditions will remain very accommodative for
most of 2021. We expect Hungary's NBH to ease 15bps in Q1 2020, with the terminal 1w rate at 0.60%. The
3m Bubor rate is likely to start gradually moving higher later in 2021, however. In Poland, front-end FRAs are
priced the base rate to stay flat throughout 2021, in line with our expectations. Looking further out the curve,
our expectation is for the 5y PLN-EUR swap spread to remain stable at around ~60bps in the coming months.
Hence, we like receiving 5y PLN IRS for 1 year given the attractive carry and roll-down of approx. 25bps. In
Turkey, policy rates must tighten further. Front-end implied yields have adjusted higher, as we expected, and
are set to fall in the 1-2yr area becoming more inverted - we like flatteners in this part of the curve (O/N minus
12m rates should flatten ~180bps). In South Africa, the yield curve is one of the steepest in EMs. The longend of the curve would be even steeper, we think, without SARB's QE. One interesting aspect concerning the
ZAR swap (vs 3m Jibar) curve is the hefty carry, especially if positions are held for longer than 3 months, and
the equally attractive roll down. We like to receive 5y Swaps with carry and roll of approximately 79bps if the
position is put on against 1y forwards. We also expect front-end G-spread tightening in ZAR SSAs that are on
very wide levels in historical terms. In Russia, there continues to be 'room to cut rates further.' Thus, rates are
likely to stay stable around current levels or go lower. As the Finance Ministry has already placed record OFZ
in the market in 2020, mostly issuing FRNs in Q3 and Q4, there seems to be little ahead in the way of forcing
the yield curve higher. Heavy US sanctions maybe, but lacking any event of such magnitude, the curve should
move lower and bull flatten in 2021. We like to receive 3y swaps with carry and roll of ~49bps if position (vs 3m
MosPrime) is held for 1y.
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
21
Market Musings
EM Forecasts
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
22
Market Musings
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
23
Recent Publications
Global Rates, FX & Commodities Strategy
Global Macro
Region
Publication
Date
Weekly
Upcoming Week - The Big Three (14 Dec)
11 Dec
Week Ahead: Canada Macro Market Movers
14 Dec
Week Ahead: US Macro Market Movers
14 Dec
ECB Commentary - Oh Come All Ye Favourable Financing Conditions
10 Dec
Trading the BoC
10 Dec
Nov CPI: Still Tame (and Claims Rising)
10 Dec
ECB Does Just Enough, Hawkish Risk into Press Conference
10 Dec
US COVID: No Peaking Yet
14 Dec
Fed Balance Sheet Tracker
10 Dec
US Social Distancing Tracker
8 Dec
US COVID: Hospitalizations Trending Up
4 Dec
Fed Balance Sheet Tracker
3 Dec
Bank of Canada Balance Sheet Tracker
14 Dec
Bank of Canada Balance Sheet Tracker
7 Dec
Europe Social Distancing Tracker
8 Dec
Europe Social Distancing Tracker
1 Dec
Weekly
I'm Still Standing
11 Dec
US
Fed Balance Sheet Tracker
10 Dec
10y Treasuries: Buy the Dip
9 Dec
Fed Balance Sheet Tracker
3 Dec
Bank of Canada Balance Sheet Tracker
14 Dec
Bank of Canada Balance Sheet Tracker
7 Dec
Holding Through The Extension
4 Dec
Europe
The ECB's Permanent Band-Aids For Markets
2 Dec
Trades
Taking Profit on Short Jul 2021 Fed Funds
14 Dec
Stop hit on TCV 09/31 - ACGB 11/31 Compression trade
7 Dec
Enter 10s30s CAD Steepeners and CAN-US Box
1 Dec
Analysis
GBP: Pondering The Pound's Positioning
7 Dec
Trades
Close Trade of the Week: USDCHF Long
14 Dec
Sell CADJPY - Trade of the Week (TOTW)
14 Dec
Buy USDCHF - Trade of the Week (TOTW)
7 Dec
Close Long USDCAD and AUDNZD
7 Dec
China Total Social Financing Peaking Out
10 Dec
China's 2021 Economic Policy Outlook
3 Dec
Weekly
Commentary
Commentary
Commentary
Commentary
Commentary
US
US
US
US
US
US
Canada
Canada
Canada
Europe
Europe
Europe
Rates
Weekly
US
US
US
Canada
Canada
Canada
Canada
Europe
Trades
Trades
Trades
FX
Analysis
Trades
Trades
Trades
Trades
EM
Analysis
Analysis
Analysis
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
24
Commodities
Analysis
2021 Commodities Outlook: A Time for Commodities in New Post-COVID World
11 Dec
OPEC+ Deal to Gradually Ease Output Bodes Well for $50+ Crude Next Year
3 Dec
Red Hot Copper Running on Fumes
2 Dec
Taking Profits on Long Heating Oil Spread
3 Dec
Analysis
Analysis
Analysis
Trades
Trades
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
25
Global Strategy
Global Rates, FX & Commodities Strategy
Global Strategy
Richard Kelly
Head of Global Strategy
richard.kelly@tdsecurities.com
44 (0)20 7786 8448
James Rossiter
Head of Global Macro Strategy
james.rossiter@tdsecurities.com
44 (0)20 7786 8422
Jim O'Sullivan
Chief US Macro Strategist
jim.osullivan@tdsecurities.com
1 212 827 6922
Jacqui Douglas
Chief European Macro Strategist
jacqui.douglas@tdsecurities.com
44 (0)20 7786 8439
Robert Both
Macro Strategist
robert.both@tdsecurities.com
1 416 983 0859
Oscar Munoz
Macro Strategist
oscar.munoz@tdsecurities.com
1 212 827 7405
Priya Misra
Head of Global Rates Strategy
priya.misra@tdsecurities.com
1 212 827 7156
Andrew Kelvin
Chief Canada Strategist
andrew.kelvin@tdsecurities.com
1 416 983 7184
Prashant Newnaha
Senior Asia-Pacific Rates Strategist
prashant.newnaha@tdsecurities.com
65 6500 8047
Gennadiy Goldberg
Senior US Rates Strategist
gennadiy.goldberg@tdsecurities.com
1 212 827 7180
Pooja Kumra
Senior European Rates Strategist
pooja.kumra@tdsecurities.com
44 (0)20 7786 8433
Chris Whelan
Senior Canada Rates Strategist
chris.whelan@tdsecurities.com
1 416 983 0445
Penglu Zhao
G10 Rates Quantitative Strategist
penglu.zhao@tdsecurities.com
1 212 827 7643
Mark McCormick
Global Head of FX Strategy
mark.mccormick@tdsecurities.com
1 416 982 7784
Ned Rumpeltin
European Head of FX Strategy
ned.rumpeltin@tdsecurities.com
44 (0)20 7786 8420
Mazen Issa
Senior FX Strategist
mazen.issa@tdsecurities.com
1 212 827 7182
Ray Ng
FX Quantitative Strategist
ray.ng@tdsecurities.com
Cristian Maggio
Head of Emerging Markets Strategy
cristian.maggio@tdsecurities.com
44 (0)20 7786 8436
Sacha Tihanyi
Deputy Head of Emerging Markets Strategy
sacha.tihanyi@tdsecurities.com
1 416 307 7699
Mitul Kotecha
Senior Emerging Markets Strategist
mitul.kotecha@tdsecurities.com
65 6500 8047
Izidor Flajsman
Emerging Markets Strategist
izidor.flajsman@tdsecurities.com
44 (0)207 786 8414
Alex Loo
Emerging Markets Strategist
alex.loo@tdsecurities.com
Bart Melek
Head of Commodity Strategy
bart.melek@tdsecurities.com
1 416 983 9288
Ryan McKay
Commodity Strategist
ryan.mckay@tdsecurities.com
1 416 982 5816
Daniel Ghali
Commodity Strategist
daniel.ghali@tdsecurities.com
1 416 983 8075
Global Macro
Global Rates
FX Strategy
EM Strategy
Commodities
TD Securities
Global Rates, FX & Commodities Strategy 15 December 2020
26
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