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Capital flows to EMs set to weaken

June 9, 2022by Nicholas Kabaso
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Local Market Commentary

  • The focus in Zambia remains on news flow amid a dearth of domestic data. Zambia is reportedly considering being the next country to take UK asylum seekers after “expressing an interest” in the Government’s Rwanda scheme. A report quoting a source familiar with the matter suggests that Zambia is “potentially interested” but is waiting to see how the £120mn agreement to remove migrants from the UK to claim asylum in Rwanda works and whether it is worthwhile and the political ramifications of it.
  • Data published this week confirmed that the rotation out of emerging market assets persisted last month as money managers continued to favour haven assets given the fragile market conditions. According to the Institute of International Finance, emerging market bonds and equities suffered a -$4.9bn capital outflow in May as concerns about a global recession, geopolitical tensions, tighter monetary conditions and inflationary pressures weighed on risk appetite. This comes on the back of a -$4.0bn outflow in April and a -$9.8bn outflow in March.
  • Details from the May Capital Flows Tracker report showed that most of the outflows were from China, which doesn’t come as a surprise as several major cities remained in lockdown. That said, the last week of May saw important inflows into Chinese assets as officials signalled that they would ease lockdowns. Moreover, it is worth pointing out that May saw marginal inflows into Africa and the Middle East ($2.7bn).
  • While the modest inflows into Africa and the Middle East last month are encouraging, the IIF said in its global outlook report that capital flows to emerging markets are expected to weaken markedly due to the elevated global recession risks. The IIF forecasts that non-resident flows to emerging market countries, excluding China, will fall to $645bn in 2022, from about $1trn last year. It also expects a continuation of recent outflows in China.
  • However, for Africa and the Middle East, the institute said that it expects a return to strong growth and large current account surpluses, with “a certain degree of resilience on the part of oil-exporting countries despite the challenging global growth environment. Countries such as Angola and Nigeria are benefitting handsomely from the elevated international oil prices. For an in-depth analysis on this topic, see our latest strategy piece titled “Current account dynamics are playing a key role in African currency movements.”
  • The benchmark 3m LME copper contract has slipped this morning in the Asian session largely as a result of a stronger dollar which is driving short-term price action. The metal is holding around the $9700.00/tonne mark as the EU open beckons with $9600.00/tonne seen as the floor for now.
  • There has been a bit of a wobble coming out of China with news that parts of Shanghai began imposing new lockdown restrictions on Thursday. Reuters reported that residents of the sprawling Minhang district were forced to stay home for two days in a bid to control COVID-19 transmission risks.
  • The LME is under the spotlight over the cancelled trades during the wild trading in March. There are a number of lawsuits pending and there has now been an official complaint made by a hedge fund association. “The LME has undermined confidence in its ability to oversee markets by failing to perform its regulatory obligations to maintain an orderly market, manage conflicts of interest and protect investors in the nickel market,” the Managed Funds Association (MFA) said
  • In the FX market,  the USD is still struggling for clear direction. On the one hand, bond yields are rising again, and there is uncertainty in equity markets, but on the other, the USD is expensive, and there is a lot priced into U.S. financial markets concerning monetary tightening. Although the recent data out of the U.S. has been supportive and positive, some cracks are starting to show, and many organisations are revising their growth expectations downwards quite strongly. That should keep the USD’s appreciation capped, although another bout of risk aversion will likely translate into another mini-surge in the USD. The JPY remains on the defensive and trading back above 134.00/dlr, while the EUR is still consolidating around 1.0700 and the GBP around 1.2500.

 

Rand and International FX Commentary

  • It is extraordinary the ZAR is performing as well as it is despite so much geopolitical uncertainty and the dysfunction of the ports and railway network. One could only imagine how much more benefit SA might’ve enjoyed had Transnet and the ports been fully functional. This morning, an article in Business Day makes the point as it alludes to the slump in coal exports despite a serious supply crunch that drove coal prices up more than oil prices. At one point earlier this year, coal prices had risen by more than three times the oil price, but SA was battling a poor performance by Transnet and the Richards Bay coal terminal, where throughput at times is only a fraction of what it could be.
  • That is a pity, as it might’ve contributed to the sector’s performance within GDP, helped employ more workers and kept the ZAR stronger to offset much of the international ravages of inflation. But the cost of inefficiencies can oftentimes be inflation. It is another story of how SA has not been able to capitalise on its very strong terms of trade fully yet still offers insight into where much of its resilience has come from.
  • According to the Institute for International Finance, emerging markets suffered a significant net outflow in May. The ZAR did experience some aggressive selling in the early stages of the month but stabilised and recovered later in May, only for the appreciation to extend through June. In the face of all the noise, uncertainty, offshore rate hikes, and the draining of liquidity, flows have remained somewhat supportive of the ZAR, and ETM’s ZAR Sentiment indicator still signals a supportive environment for the ZAR through the next 6-8 months.
  • Even ETM’s carry attractiveness index shows that SA enjoys a stronger carry score than many other emerging markets and definitely more than developed markets. That may speak to the conservatism of the SARB and the recent hikes and the rise in inflation internationally that will undermine the PPP balance of forces that exists. So while the USD is struggling for traction, as is the case this morning, the ZAR will capitalise, with technical analysis targeting levels back below 15.2000 today.

Nicholas Kabaso

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