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

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% EM x-China FX at Historical Lows on Real Basis 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 Advanced Economy Look Similar EM Growth Could Fall Even More Than Advanced Economies Near-term Growth Hit Is Substantial Longer Term Still Great And Could Fall Even More With A 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 Capital Outflows From EM Worse Than In Other Events Compounding The Problem Was The Surge In Covid Cases In EM1 Cases Are Rising In EM While Falling For DM…. Along With Deaths Step 3: Find Potential Repricing Catalysts Catalyst 1: The Return Of US QE Weakens USD Developed Countries Are Returning To QE1 At that could mean a weaker USD 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… While The Unwinding Of QE Reverse Those Flows 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 Up Until Recently Oil Seemed Immune To the USD But… Catalyst 1: Return of US QE Weaken USD--- That Provides Tailwind To Commodity EM Economies The USD Has Rallied As The Fed Hikes Rates Historical Impact of Dollar On Lat-Am Growth Catalyst 2: Commodity EMs Has Room To Deploy Monetary And Fiscal Stimulus--Case Of Brazil Pension Reform Reduces Fiscal Pressures Brazil’s Commodity Footprint Growing: Example of Oil Catalyst 2: Commodity EMs Has Room To Deploy Monetary And Fiscal Stimulus--Case Of Mexico Fiscal Restraint Now Given Mexico Room For Fiscal Stimulus Investment in Pemex Will Increase Future Oil Production Catalyst 2: Commodity EMs Has Room To Deploy Monetary And Fiscal Stimulus--Case of Russia Reserves Have Surged While External Debt Exposure Has Shrunk Reserves Have Surged While External Debt Exposure Has Shrunk Catalysts 3: EM Is Bending The Curve Of Covid Using The Same Lockdown Strategy As DM New Cases Are Slowing Converging To The US Slowing Reflects Impact of Similar Containment Strategies As US 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 Commodity EM FX Still Have Room To Rally vs USD Copyright (c) SOM Macro Strategies. 2020. 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Covid-19 – Part 3: The Fall Of The USD & The Rise Of EM

Alan Brazil

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

Alan Brazil

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