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Trade Floor Update: EM Outlook, Mexico, Brazil

While PIMCO’s cyclical outlook is cautious overall, our outlook for emerging markets is more constructive.

In this month’s Trade Floor Update we sat down with Lupin Rahman, Emerging Markets Portfolio Manager, to discuss market moves, our current outlook for emerging markets, and events in Mexico and Brazil. Below is a transcript, edited for length and clarity. You can watch the full video here.

Q: What were the main factors driving markets in November?

A: Markets were generally constructive in November. The appointment of Powell as Fed chair alleviated some of the concern the market had of a hawkish Federal Reserve, resulting in a modest rally in U.S. Treasuries and a bull flattening of the U.S. Treasury curve. Together with dollar weakness, this resulted in global FX strength, led by the yen and euro, and emerging market (EM) strength, led by Asian FX and emerging European currencies. The asset class that underperformed moderately was credit, in particular high-yield and EM, where spreads were wider by about ten basis points.

Q: What’s PIMCO’s current outlook on emerging markets?

A: The global backdrop is very constructive for emerging markets at the current juncture. We have a relatively dovish Fed. We also have very strong global macro-fundamentals and a China where we're seeing a soft landing. All of this has been supportive of inflows into the asset class, which has also supported asset prices. The one area where we're slightly more cautious is emerging market valuations. As you know, we've seen quite a strong rally year to date. Here we're really focusing on alpha opportunities rather than looking at the asset class as a generic beta play.

Q: What is happening in Mexico given the NAFTA negotiations and upcoming elections?

A: Mexican markets have been relatively resilient in spite of the NAFTA negotiations and the upcoming presidential elections in 2018. The peso has rallied and spreads are tighter this year. This out-performance has actually continued into November, which is quite remarkable.

On the NAFTA front, the negotiations are continuing on the fifth and sixth rounds. The real risk here is that delays press into the electoral cycles in both Mexico and the U.S. Our baseline is that there will be some mutually beneficial agreement coming in place, but the transition to that point may include a lot of noise and volatility.

On the presidential elections, it's still too early to call. The risk is that the more populist candidate, Lopez Obrador, gains in the polls and even wins. This may unwind some of the structural reforms that Mexico has undertaken in the last couple of years.

Q: What are the implications if South Africa gets downgraded to junk?

A: If Moody’s should follow S&P in downgrading South Africa’s local currency credit rating to “junk”, South Africa would come out of global bond indices, resulting in relatively large capital outflows, affecting both the Rand and local rates. The trigger factors that we're looking for are the outcome of the ANC Elective Conference in December – whether there is a market friendly or market unfriendly candidate – and the February 2018 budget. Signs of fiscal consolidation in this budget will be extremely important to signal that South Africa is still on a reform agenda path.

Q: What’s PIMCO’s outlook on Brazil?

A: The current central bank governor has done a remarkable job in terms of anchoring credibility and inflation expectations. What we're expecting, going into next year, is that the central bank will remain more or less on hold but look to hike rates around the time of the election in November and December.

The other thing to note about Brazil is that the electoral related volatility this time around may be relatively high. It's still too early to call the elections, but there are possibilities of ex-president Lula being one of the candidates, as well as other more heterodox candidates who are gaining momentum as the anti-establishment vote in Brazil grows.

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The Author

Lupin Rahman

Head of EM Sovereign Credit

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This Research paper is a joint effort between PIMCO and GIC, Singapore’s sovereign wealth fund. GIC authors Grace Qiu Tiantian Ph.D., Ding Li, and Zhihui Yap collaborated with PIMCO’s Josh Davis, German Ramirez, and Helen Guo to produce this report.

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