Stocks up 0.5pc, focus on central banks

LONDON: Emerging equities rose for a third straight session on Tuesday as encouraging recent US data remained supportive, but slowing growth in developing economies is shifting the focus to what direction central bank policy will now take.

MSCI's emerging equities rose half a percent to 12-day highs after breaking a four-week losing streak last week on signs the US economy may not be headed for recession after all. Trade was thinned by a Muslim holiday in parts of Asia and the Middle East while investors are reluctant to make big bets before US jobs and manufacturing data due later this week.

"People are a bit more optimistic after we got through last week's Bernanke episode without major trauma. U.S markets closing firmer on Friday was a catalyst for this week's stronger open," said Nigel Rendell, emerging markets strategist at RBC Capital Markets.

He was referring to last Friday's speech by US Federal Reserve chief Ben Bernanke which some had expected would be used to announce another dose of stimulus for the US economy. Bernanke did not signal any fresh measures during his speech, although he said the Fed would consider its options at an extended policy meeting next month.

"There seems to be a bit of cautious optimism, people are returning to markets that looked oversold. But we have a long way to go before things look on an even keel in the United States and Europe," Rendell added.

Growth data for emerging economies was mixed. India reported 7.7 percent annual growth in the April-June quarter, its weakest pace in six quarters, pushing Indian 10-year yields to two-week highs.

Poland expanded by a faster-than-expected 4.3 percent in the second quarter. Analysts, however, said that growth would ease in coming months, predicting a marked slowdown in industry, retail sales and exports to the euro zone.

The zloty firmed after the data but later reversed course.

BNP Paribas predicted the zloty would strengthen.

"We believe that today's release was robust and supportive for Polish markets. Since the release, risk has risen a bit globally, which has prevented the zloty from strengthening but we would expect some outperformance of the zloty in the region," they said.

South Africa's GDP growth meanwhile slowed in the second quarter, rising 3 percent year-on-year versus 3.5 percent in the first quarter. Benchmark bond yields eased slightly while the rand was flat to the dollar.

"The outcome is a lot softer than people were expecting. I think this will keep speculation about a possible rate cut going. We have seen the (forward rate) market react to that already this morning, so I think the bond market will stay in bullish mode for now," said Leon Myburgh, a strategist at Citi.

CENTRAL BANKS IN FOCUS

South African bonds outperformed in August with front-end yields falling 80 basis points. Central bank Governor Gill Marcus said last week that the bank would "act appropriately" if the global economy slows.

Bonds across emerging markets have rallied as the global economy threatened to slow more than expected and investors priced in rate cuts. But some of those bets have been dashed, as central banks in India and China in particular, signalled their determination to curb inflation.

Chinese interest rate swaps rose and the one-year IRS hit a record high 4.37 percent . The curve is inverted after a change in bank reserve requirements caused a liquidity shortage and forced players to wind up short positions built in hope of a policy tightening pause.

Analysts say Poland's strong growth will encourage it to leave interest rates on hold. One central banker added her voice on Tuesday to the no-rate cuts camp, noting that inflation was high and economic growth solid.

Markets are also paring rate cut expectations for Israel after the central bank signalled on Monday that rates would stay on hold for the foreseeable future. That helped the shekel firm to a 10-day high to the dollar after falling around 4 percent in the past month as markets bet on rate cuts.

"There was a big swing towards easier monetary policy in emerging markets from tighter policy but central banks for the most part haven't gone along with that," RBC's Rendell said. "We've probably had the lion's share of gains in bonds already."

Central bank action was also in focus in Kenya where interbank rates have shot up amid a liquidity squeeze, to 28 percent from 8 percent two weeks ago.

The bank tried to address the liquidity shortage on Monday by engineering a sharp cut in the discount rate, pushing the shilling down almost 2 percent.

The currency steadied on Tuesday and interbank rates were expected to ease along with the discount rate.

The shilling is one of this year's worst-performing emerging currencies, having lost 14 percent to the dollar.

"They should have been raising interest rates but instead they have been taking a series of piecemeal approaches such as changing the discount window and that's undermining international investors' confidence," said Stuart Culverhouse, head of research at Exotix, a frontier markets brokers.

Emerging sovereign bond yield spreads were 4 basis points wider over U.S Treasuries.

Copyright Reuters, 2011