Alan Brazil SOM Macro

June 18, 2020

Covid-19 – Part 3: The Fall Of The USD & The Rise Of EM

BY Alan Brazil

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( 7 mins)

June 16, 2020 (Updated) Alan Brazil

  • Step 1: Macro Theme: The Sell-off In Commodity EM Assets Is A Buying Opportunity
    • EM x-China equities have lagged the rebound in US and China equities
    • EM x-China FX are at historical lows on a real basis
  • Step 2: Fundamental Economic Framework
    • EM economies will be harder hit than DM economies from the Covid-19 lockdowns
    • The fall in commodity prices adds to the downward pressures on EM
    • Capital outflows from EM is almost twice as large as in previous EM risk-off events
    • EM Covid cases and deaths seem to be accelerating vs DM countries
  • Step 3: Find Potential Repricing Catalysts
    • The return of US QE could push commodity EM assets higher by weakening the USD
      • Weaker USD could increase capital flows to EM
      • Weaker USD could strengthen commodity prices
      • Weaker USD could provide a tail wind to commodity EM GDP
    • Commodity EM countries have the capacity to deploy substantial fiscal stimulus to support their economies
    • EM countries are bending the Covid infection curve using even stricter lockdown strategies relative to the US
  • Step 4: Find Asymmetric Trade
    • Trade: Buy commodity EM FX vs the USD

 

Step 1: Identify Macro Theme

The Sell-Off In Commodity EM Assets Is A Buying Opportunity

EM x-China Equities Still Down over 25%

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 29

EM x-China FX at Historical Lows on Real Basis

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 30

 

Step 2: Fundamental Economic Framework

Economic Recovery Will Likely Be U-Shaped At Best Not V-Shaped

World GDP a “U” or A “W” Recovery

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 31

 

Advanced Economy Look Similar

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 32


EM Growth Could Fall Even More Than Advanced Economies

Near-term Growth Hit Is Substantial

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 33

Longer Term Still Great And Could Fall Even More With A

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 34

Falling GDP Combined With The Fall In Commodity Prices Led To Capital Outflows From EM

Demand Erosion Led To A Sudden Drop In Commodity Prices

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 35

 

Capital Outflows From EM Worse Than In Other Events

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 36

 

Compounding The Problem Was The Surge In Covid Cases In EM1

 

Cases Are Rising In EM While Falling For DM….

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 37

 

Along With Deaths

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 38

 

Step 3: Find Potential Repricing Catalysts

Catalyst 1: The Return Of US QE Weakens USD

Developed Countries Are Returning To QE1

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 39

 

At that could mean a weaker USD

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 40

Catalyst 1: Return Of US QE Weakens USD– Increases Capital Flows And Drives Up EM FXI1

US QE Was A Major Factor in Driving Capital Flows To EM…

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 41

 

While The Unwinding Of QE Reverse Those Flows

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 42

 

Catalyst 1: Return Of US QE Weakens USD—Drives Up Commodity Prices And Commodity EM GDP

Stronger USD Could Affect EM Through A Fall In Commodity Prices

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 43

Up Until Recently Oil Seemed Immune To the USD But…Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 44

 

Catalyst 1: Return of US QE Weaken USD— That Provides Tailwind To Commodity EM Economies

The USD Has Rallied As The Fed Hikes RatesCovid-19 - Part 3: The Fall Of The USD & The Rise Of EM 45

Historical Impact of Dollar On Lat-Am GrowthCovid-19 - Part 3: The Fall Of The USD & The Rise Of EM 46

Catalyst 2: Commodity EMs Has Room To Deploy Monetary And Fiscal Stimulus–Case Of Brazil

Pension Reform Reduces Fiscal PressuresCovid-19 - Part 3: The Fall Of The USD & The Rise Of EM 47

 

Brazil’s Commodity Footprint Growing: Example of Oil

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 48

 

 

Catalyst 2: Commodity EMs Has Room To Deploy Monetary And Fiscal Stimulus–Case Of Mexico

Fiscal Restraint Now Given Mexico Room For Fiscal Stimulus

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 49

 

Investment in Pemex Will Increase Future Oil Production

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 50

Catalyst 2: Commodity EMs Has Room To Deploy Monetary And Fiscal Stimulus–Case of Russia

Reserves Have Surged While External Debt Exposure Has Shrunk

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 51

Reserves Have Surged While External Debt Exposure Has Shrunk

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 52

Catalysts 3: EM Is Bending The Curve Of Covid Using The Same Lockdown Strategy As DM

New Cases Are Slowing Converging To The US

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 53

 

Slowing Reflects Impact of Similar Containment Strategies As USCovid-19 - Part 3: The Fall Of The USD & The Rise Of EM 54

Step 4: Identify Asymmetric Trades

Buy A Basket of Commodity EM FX Vs USD Cases

Trade Thesis

  • EM commodity country FX should appreciate vs the USD
  • US QE will weaken the USD vs commodity EM FX
    • QE will drive capital flows to EM
    • Weaker USD will drive up commodity pries helping commodity EM Countries
  • Commodity country EMs have the capacity for fiscal stimulus that should support their economies and reduce risk
  • EM countries have used even stricter containment strategies vs the US to bend the Covid curve

Risk is a second wave and a general risk-off environment

Negative Real Policy Rates In The US
Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 55

Commodity EM FX Still Have Room To Rally vs USD

 

Covid-19 - Part 3: The Fall Of The USD & The Rise Of EM 56

 

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