Friday, December 17, 2010

Emerging Markets Briefer ( Mexico , China , Hong Kong )

Mexico Macro Outlook 
• After last year’s contraction of 6.5%, Mexico’s economy has rebounded remarkably
in 2010. Following the impressive Q2 growth of 7.6% y/y, Q3 numbers showed a
slower yet still brisk growth at 5.3%.
• Both IMEF manufacturing and non-manufacturing indices continue on the track of
expansion, with the manufacturing index value rising to 54.0 and non-manufacturing
to 53.5 in November, from respective prior values of 53.2 and 52.2.
• In November, inflation continued creeping higher, with the yearly CPI release of
4.32% – up from 4.02% y/y in October – marking the highest annual reading since
March. Although the price growth numbers are rather robust and above the Mexican
central bank’s inflation target of 3%, the November rise in the headline figures sprang
in good part from seasonally higher electricity prices and other Christmas-related
increases, while the core component remained well in check.

Monetary Policy Outlook 
• The November rate decision in Mexico had been surrounded by a small degree of
rate cut speculation, following the Mexican central bank governor Agustin Carsten’s
dovish comments preceding the rate decision in the context of peso appreciation and
portfolio inflows. Nevertheless, the bank kept the rates unchanged at 4.5% and the
subsequent statement pointed to policymakers’ overall satisfaction with the growth
picture. Any dovish bias that there may has now faded and the central bank is set to
enter the new year with comfortable growth and inflation outlook, while certainly
keeping a close eye on the pace of portfolio inflows.

FX Outlook 
• Our outlook on the peso is little-changed from our last report. The peso is still
somewhat overvalued in relation to the longer term fair valuation, but on a three- to
12-months horizon we look for only a gradual peso weakening, although our peso
outlook is slightly on the weak side of corresponding forward prices. The currency
continues to enjoy support from the positive commodity outlook and reward moderate
but nevertheless steady carry gains when held against the US dollar. In terms of the
technical picture, however, the peso has  seen upside momentum stall with the
USD/MXN sideways move from mid-November taking the steam out of peso gains.

China Macro Outlook 
• Recent data has confirmed that growth in China is again accelerating, supported by
solid domestic demand and some improvement in exports. We expect GDP growth in
China to exceed potential in H1 11 after having been below potential in Q2 and Q3
and around potential in Q4 10. Growth is expected to slow in H2 11 as monetary as
well as fiscal policy gradually become less accommodative.
• Inflation in November surged for the second month in a row to 5.1% y/y. Although
the increase in inflation has largely been driven by higher food prices, there are signs
of the inflationary pressure spreading. Inflation is expected to temporarily drop in
December before accelerating again above 5% in Q1 11. Inflation should start to ease
in H2 11 as the impact from higher food prices starts to wane. However, with China
reluctant to tighten monetary policy and core inflation likely to edge higher, there is
an increasing upside risk to our inflation forecast, particularly in H2 11.

Monetary Policy Outlook 
• The People’s Bank of China (PBoC) has already signalled a shift in monetary policy
from ‘moderately loose’ to ‘prudent’ (basically neutral) and has started a tightening
cycle by raising its benchmark interest rates in October and the reserve requirement
four times since October. PBoC is, in our view, behind the curve in terms of monetary
tightening and the pace of monetary tightening is set to increase. We expect four rate
hikes over the next year and still believe a rate hike is possible in late December. The
rate hikes are expected to be frontloaded into H1 11.

FX outlook 
• Since China abandoned its USD peg in June, CNY has appreciated by 2.7% against
USD. However, the pace of appreciation has again slowed, as CNY has been broadly
unchanged against USD since late October.
• Faster appreciation of CNY is likely to be part of China’s policy response to
increasing inflationary pressure. We expect CNY to appreciate by 7% against USD
over the next year, with a large part of the appreciation frontloaded into H1 11. In
addition, international political pressure will continue to be important for the timing
of the expected appreciation. Hence, we  are likely to see renewed appreciation of
CNY ahead Chinese President Hu Jintao’s official visit to the US in late January

Hong Kong Macro Outlook 
• GDP growth in Hong Kong has again started accelerating after some weakness
earlier. In Q3 10 growth was mainly driven by solid domestic demand as exports to
China remained relatively weak. With growth in China again accelerating, stronger
exports to China are expected to be an additional boost to growth in the coming
• With real interest rates negative and major capital inflows from mainland China, there
is an increasing risk of a bubble on Hong Kong’s property market. In November, the
required down-payment for property purchases was raised and a 15% duty was
introduced for apartments sold within six months of purchase.
• Inflation is edging higher and could exceed 3% y/y in early 2011.

 Monetary Policy Outlook 
• Due to Hong Kong’s USD currency board, interest rates are linked to their US
counterparts. As a result, money market rates are expected to remain unchanged until
Q3 12. With Hong Kong’s growth increasingly decoupling from the US, pegging
monetary policy to the US could be potentially destabilising.

FX Outlook 
• Hong Kong’s currency is pegged to USD within a very tight trading band (see chart
below) and Hong Kong’s Monetary Authority (MA) intervenes in the FX market to
keep HKD within its trading band. Because of the currency board, all HKD issues
have to be backed by USD assets.
• Hong Kong is expected to maintain its USD peg for the foreseeable future. Full CNY
convertibility is probably a necessary condition for HKD to abandon its USD peg, and
this is unlikely to happen within the next five years. However, the importance of CNY
will gradually increase, and CNY is already starting to function as a parallel currency
in Hong Kong. This will also make the path towards a CNY linkage more gradual. As
part of its movement towards full convertibility, China has in recent months started an
offshore CNY market in Hong Kong. This is an extremely positive development for
the financial sector in Hong Kong.
Full report : Emerging Markets Briefer ( Mexico  , China  , Hong Kong )

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