August2016: #BRIC Fundamental Commentary.

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BRAZIL — The slight adjustment in the trade-weighted US dollar (USD) has given some relief to US-dominated trading dynamics in the developing Americas. The Brazilian real (BRL) continues to be a market-favourite in a global trading context driven by a steady pursuit of yield. The BRL has been quite indifferent to the global market uncertainties stemming from the UK referendum outcome last June and remain relatively unfazed by domestic electoral uncertainties in the USA ahead of the November 8th vote. Global market participants have given the interim government of President Michel Temer a confidence vote for now, something that has been compounded by the still attractive interest rate differentials offered by Brazilian government securities. Nondeliverable forward contracts have steadily discounted an improvement in the currency outlook for Brazil, discounting a 3.40 per USD exchange rate by the end of the current calendar year. On the macroeconomic front, recent data highlights a slight moderation in inflationary pressures with the headline consumer price inflation rate at 8.8% y/y in June (down from 10.7% y/y in January); the consensus tracked by the central bank estimates an end-year rate of 7.2%. Although industrial production remains in negative growth territory, there are positive signs of reversal found in the adjustment of the external sector; indeed, the trade balance is estimated to be in surplus in both 2016 and 2017, contributing to the reduction in the current account deficit to 0.8% of GDP in both years.
July has not been as good a month for BRL as the rest of the year, with the real down about 1% in the month. This contrasts with a world beating +21% rally year to date (top “expanded-major FX”). However, after the latest version of the COPOM’s minutes (released July 26th) suggested that markets were pricing too aggressive and early an easing cycle, the BRL should get some additional carry support.
RUSSIA — The worst of Russia’s economic crisis has passed, with the contraction in real GDP easing to its lowest rate since the country slipped into recession in early 2015, at -0.6% y/y in the second quarter — down from -1.2% in the first three months of 2016 and -3.8% in the final quarter of 2015. The Economy Ministry said that “industrial production, transport and agriculture were the main factors behind the contraction slowdown”, while construction and retail sales continued to weigh negatively on Q2 growth. The Russian economy looks poised to eke out of recession this year, however, strong evidence of a turnaround has yet to materialize, with oil prices still at relatively low levels and Western sanctions following Russia’s annexation of Crimea likely to remain in place through year-end at a minimum. The Russian Central Bank Governor has also emphasized the country’s need for structural reforms and measures to improve the business climate. After contracting by 3.7% in 2015, we expect that Russian real GDP will decline by   -1% this year before returning to growth of 1½% on average in 2017. After cutting its benchmark repo rate by 50 basis points in June to 10.5%, the Central Bank of Russia remained on hold in July, amid concerns over elevated medium-term inflation expectations and above target inflation, at 7.5% y/y in June. Central bank policymakers are hoping that relatively tight monetary conditions will help reduce elevated price pressures and would consider a further rate cut at its next meeting if inflation risks recede.
After trading in a more stable range for several months, the RUB has experienced renewed weakness on the back of bearish oil market conditions. Indeed, the RUB depreciated by roughly 3% against the USD over the past month alongside the sharp fall in Brent crude oil prices. Expectations of weaker oil prices and further losses in Russian assets will likely continue to weigh on the RUB in the months ahead. We expect USDRUB to end 2016 at 68.5.
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INDIA — The Reserve Bank of India (RBI) is in the midst of leadership transition causing investor concerns regarding monetary policy continuity. Governor Raghuram Rajan will step down in early September and his successor has yet to be announced. Mr. Rajan continues to emphasize the importance of maintaining inflation-focused monetary policy beyond his term, as it is vital for policy credibility and investor confidence. Within the next few months, the RBI’s monetary policy decision is expected to be made by a monetary policy committee (consisting of three government representatives and three from the central bank), instead of by the governor alone; however, the timeline for this change and the names of the policymakers have yet to be confirmed. We expect the RBI to leave the benchmark interest rate unchanged at 6.50% on August 9th given that it is Governor Rajan’s last meeting. Once the new RBI structure is in place, the key rate will likely be cut by 25 basis points to 6.25%. Inflation remained at 5.8% y/y in June, but has accelerated from the 4.8% reading three months earlier due to higher food prices. Nevertheless, inflation remains in line with the long-term target of 4% ±2 percentage points. The monsoon session of parliament is ongoing; expectations are high for the passage of the long-stalled Goods and Services Tax Bill — an important tax reform proposal that would help improve India’s business environment.
We expect the high-yielding INR to benefit from prospective portfolio inflows amid ample external liquidity as the government will push forward economic reforms including the GST Bill and the RBI will ease monetary policy further in H2. We stay with our short GBPINR cross on divergent growth outlook to chase a higher return, with a target of 80 and a stop of 95. USDINR is likely to trade in a range of 66.0 to 68.0 in August. However, we will turn modestly bullish on USDINR near Jackson Hole Symposium.
CHINA — Most of China’s June high frequency data came in above expectations, including industrial production, retail sales, money supply, and credit. Reflecting this June pick-up, second quarter real GDP was also slightly higher than anticipated; the Chinese economy expanded by 6.7% y/y, in line with the pace recorded in the first quarter. A large part of this momentum reflects authorities’ recent stimulus measures; accordingly, such high rates are not sustainable in the medium term. We expect to see China’s output growth to dip below the 6½% y/y mark by the end of the year with expansion averaging 6.5% in 2016 as a whole. Weakening momentum is driven by a more muted industrial sector (partially reflecting factory closures ahead of the G-20 Summit in early September); meanwhile, the services sector continues to be the driving force of the economy. Chinese policymakers will likely unveil additional fiscal stimulus measures over the coming months. In our view, public outlays will serve as the main policy avenue to deal with the strong decelerating forces that the Chinese economy is facing, given that monetary easing stimulates lending and has already resulted in a ballooning of private sector credit. China’s inflation outlook remains manageable and allows for further injections of stimulus; we expect consumer price gains to hover near 2% y/y through 2017. The headline rate remained at 1.9% y/y in July.
While the depreciating pressure on the yuan remains in place through the rest of this year, the PBoC will continue to maintain a relatively stable yuan basket ahead of the G-20 Hangzhou Summit in September and the World Bank’s planned issuance of SDR-denominated bonds due as early as August. USDCNY is forecasted to trade between 6.60 and 6.70 in August. Meanwhile, continued offshore yuan supply stemming from mainland investors’ southbound stock purchases improves CNH liquidity conditions that help cap USDCNH forward points.
#Forex #BRIC Country #Currency Chart August’16

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