GEM Strategy - Chinese and Turkish LEI surprise to the upside, Russia leaves the policy rate unchanged

• China – positive risk to growth with strong LEI over the weekend
• Russia – the central bank leaves the rate unchanged with inflationary expectations on the rise
• Turkey – growth surprises to the upside, is a Fed hike priced fully?

China – linking the yuan to a broad range of currencies to boost growth near-term

Some of the leading economic indicators published over the weekend show stabilization in output. The November IP (+6.7%), retail sales (+11.2%), and fixed asset investments (+10.2%) have all surprised to the upside. The weekend statistics are consistent with the recent macro and sector data points – including growth in loan originations, a 16% jump in automotive production following +5% in October, moderation in the pace of decline in imports, and stabilization in consumer inflation – have reinforced the case of a moderation in Chinese output. Full year GDP is likely to read closer to 7%, possibly higher.

Moreover, the policy is likely to ease further. Indeed, after six rate cuts since 2014, the People’s Bank of China looks set to loosen the yuan’s link to the dollar and let the currency track a broader range of currencies, which should boost the prospects for growth next year. The timing of the PBOC announcement that the link between yuan and the dollar may change is also important. A rate hike by Federal Reserve next week would add to policy stimulus in China. Reducing the yuan’s peg to the dollar would work to stimulate growth medium term (2016) without creating much inflation because of output gap. The idle capacity in China, which remains significant, would offset inflationary pressures induced by weaker yuan, and help China curtail price inflation over a longer period.

Russia – the Central Bank leaves the policy rate unchanged with anticipated inflation rising

Russia’s central bank kept its benchmark interest rate at 11%. The central bank has said it will restart easing if price growth slows. The bank also says it is considering a risk scenario with an oil price remaining below $40. The central bank has indeed reduced its risk scenario oil price in 2016 to $35 a barrel but its base case remains $50.

The weaker ruble on the one hand and the restrictions imposed on Turkish food on the other are likely to keep inflation at mid-teens in the months to come. With near-term risk to inflation elevated, the Central Bank will wait at least until it sees any inflationary impact of the ban on Turkish fruits and vegetables. If implemented in January, the Turkish food ban alone would add an estimated 50bp to inflation in 1Q16. With inflationary expectations rising and no rate cut on the sight, growth in Russia is unlikely to recover anytime soon. The official estimate for 2015 GDP is 3.7% contraction followed by 0.5-1.0% decline in 2016. The upside risk to 2016 growth in Russia would be a positive surprise to Chinese growth next year.

Turkey – the mirror image of Russia

Turkish 3Q15 GDP surprises to the upside; full year growth should come in closer to 4% mark. Turkish GDP grew 4% YoY in 3Q15. This is a decent reading and it is somewhat at odds with what Turkey experienced in the third quarter. Deterioration in geopolitical risks with increasing Turkish involvement in the crisis along the southern border, election uncertainty/lack of a functioning government in the third quarter, and increasing volatility in asset prices all played into falling consumer confidence. Domestic demand contributed 290bp to 3Q GDP followed by inventory build-up (100bp) and net exports (10bp).  Sectoral breakdown of growth was uneven because of strong seasonality. Transportation and communication (+11.5% YoY) led the growth followed by education (+9.5%), and health care services (+9.0%). Other sectors lagged.

Forward looking data points also signal improvement. The October IP adjusted for working days registered 4.6% growth YoY. The November manufacturing PMI reads 50.9 indicating expansion. The economists are now busy raising GDP estimates. We are probably looking to finish the year with 3.7% growth, considerably higher than where the street forecast was in the summer months.

As in Russia, the risk to growth is inflation and inflationary expectations triggered by depreciation of the Turkish lira. Unlike Russia, inflationary expectations in Turkey are modest for two reasons. First, commodity price deflation is helping Turkey offset devaluation pass-thru. Second, the lira has probably factored-in a Fed rate hike in December. What is more important is whether the Fed policy in 2016, which is only mildly tighter on our assumptions, will amount to tighter policy elsewhere. With China firmly sticking to loose economic policy tools at her disposal and growth prospects looking bleak in other continents, we reckon the downside risk to the lira is limited and that Turkey should weather any fallout from a Fed hike next week.  

The equity trading outlook remains volatile but the valuations are approaching all-time lows. The market is currently trading at 8.0x on one-year forward earnings versus 7.2x, the 2009 low.