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Flows & Assets Report

A Quarterly Visual Guide to Capital Flows & Asset Prices


First Quarter 2015

BBVA Research
Gonzalo De Cadenas & Alvaro Ortiz (Cross Emerging Markets Unit)
Sonsoles Castillo, Alejandro Neut, Irene Roibas & Cristina Varela (Financial Scenarios Unit)

Data updated up to 27 March 2015

Why to read this report


1. The increasing globalisation has rendered Capital Flows a key ingredient in the
financial and economic performance of developed and emerging countries
2. Official capital flows data from BoP statistics often lag 6-12 months. We have
developed a DFM-FAVAR model to now-cast/forecast international portfolio
flows to close this gap (see Appendix)
3. Beyond other trackers, the model will also help us to understand the drivers
behind the swings in international portfolio flows

4. The joint analysis of economic and financial drivers allows to simulate the
reaction of international flows to alternative macro economic scenarios
(including alternative monetary policies, risk aversion and growth paths)
5. We complement this framework with analytical tools to analyse hot topics in
order to asses their potential impact on international capital flows
Page 2

Index
1. Key Messages

2. Portfolio Flows & Asset Prices: stylised facts, drivers and now-casts
3. Scenarios: Macroeconomic and Monetary Policy and Flows Scenarios
4. Hot Topic:
Russian Woes
5. Useful Information: Methodological Appendix

Key Messages

Main drivers

Divergent monetary policy paths

US dollar: strong appreciation against all currencies


Low oil prices hitting a trough

Capital flows

Now-casting signals new mild deterioration in 1Q15

Re-allocation from Emerging to Developed continues, but moderating


A temporary flight to quality during 1Q15 was followed by a search for yield

Asset prices

ECBs policy pushes the euro down while the impact of the Feds policy on EMs is uneven
Equity divergences driven by a stronger US dollar and divergent monetary policy stances.
Risk premia continue to ease (CDSs)

Forecasts & Analysis

EM Portfolio flows back to neutral after corrections; DMs entering into overvaluation area
Dollar-block assets and currencies under stress
Russian assets and flows partially recovered but caution should prevail

Capital flows
Quarterly assessment
Page 5

Now-casting of 1Q15 signals a new mild


deterioration from the long-term trend
BBVA Balance of Payments Portfolio Update
(Official Balance of Payments data, QoQ % change)

Update* of accumulated flows to Emerging Markets


(Official Balance of Payments data, in USD trn)

Update 27 Feb. 2015, Source: BBVA Research

Asia

LATAM

EM Eur

Western Europe

G4

2006 2007 2008 2009 2010 2011 2012 2013

###
###
###
0,50
1,20
3,00

USA
Japan
Canada
UK
Sweeden
Norway
Denmark
Finland
Germany
Austria
Netherlands
France
Belgium
Italy
Spain
Ireland
Portugal
Greece
Poland
Czech Rep
Hungary
Turkey
Russia
Mexico
Brazil
Chile
Colombia
Peru
Peru
Argentina
China
India
India
Korea
Thailand
Indonesia
Philippines
Hong Kong
Singapore

Update 27 Feb. 2015, Source: BBVA Research


2014

2015

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

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## #

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## #

1.0

Estimation* (3Q14)
Now-cast* (4Q14)
Forecast (1Q15)

0.8
0.6
0.4
0.2

(*) Estimation s using BBVAs DFM/FAVAR Model

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # ## #
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# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

0.0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

## #

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # ## #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # ## #
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## #

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

## #

Sharp Capital Outflows (below -2 %)


Strong Capital Outlows (between -1 % and -2 %)
Moderate Capital Outflows (between 0 and -1 %)
Moderate Capital Inflows (between 0 and 1 %)
Strong Capital Inflows (between 1 % and 2 %)
Booming Capital Inflows (greater than 2 %)

4Q14: Now-cast
1Q15: Forecast

Official Data Imbalance Assessment


(BOP official data deviations from long-term trend in USD bn)
100
50

0
-50
-100
2012

2013

2014

2015

Page 6

The re-allocation process continues with flows


leaving EMs and flying back to DMs,
particularly to Europe
Net portfolio flows as per Balance of Payments data
(Now-casted data from 1Q15: Dark blue are Net Outflows, Light Blue are Net Inflows)
Source: BBVA Research & IMF IFS
Outflows Size
-3%

Inflows Size
+3%

(*) Flows are % QoQ change in each countrys net liabilities (Equities and Bonds) measured as the ratio
of net portfolio flows in (q) to total liabilities accrued until (q-1).

EM flows were primarily driven by global


factors during most of the first quarter
EM Flows

EM Flow Drivers

(Median EM portfolio flow breakdown as per BoP, QoQ % change) Source:


BBVA Research & IMF-IFS

(Median EM portfolio flow breakdown, MoM % change) Source:


BBVA Research & EPFR

20
Local
Global
EM_BoP

15

10%

10
5

30%
35%

65%

90%
70%

-5

Phase 1-2

-10
-15

Phase 1

Phase 2

Phase 2-3

Phase 3-4

Phase 3 Phase 4

-20

2008

2009

2010

2011

2012

2013

2014

2015

Page 8

Global risk & activity profiles are reducing the


contribution of the Global Factor to flows.
Low interest rates in DM supports
BBVA Global Factor of Portfolio Flows
(First Factor from Flows using BBVAs DFM/FAVAR Model represents the main
driver of flows) Source: BBVA Research
0.4

Global risk appetite supporting flows


in February, less so in March

QE3+ Draghi Push

0.3

0.2

ECB monetary policy

0.1

Moderate improvement in DM growth

Worsening EM growth

-0.1

-0.2

US long-term rates (10Y) anchored

Activity in DMs
Activity in EMs
Interest rates US (10Y)
Interest rates EZ (10Y)

-0.3
Mar-12

Risk in Global (VIX)


Risk in EM (Embi)

Mar-13

US Tapering

Mar-14

Mar-15

Page 9

While global factor is losing momentum,


specific factors as DMs are accelerating the
reallocation process to DMs
BBVA Developed MarketFactorof Portfolio Flows
Third Factor from flows using BBVAs DFM/FAVAR Model represents
the main driver of flows) Source: BBVA Research

0.6

EM risk aversion supporting DM flows

0.5
0.4

US long-term rates (10Y) anchored

0.3
0.2
0.1

Worsening EM growth favors investing


in DMs

0
-0.1
-0.2

Less punitive DM growth expectations

-0.3
-0.4
-0.5
2013

2013

2014

Activity in Developed Markets


Activity in Emerging Markets
Interest rates in US (10 Yr)
Interest rates in the EZ (10 yr Bund)
Risk in Global (VIX)
Risk in EM (Embi)

2014

2015

Global risk appetite less suportive to


DM flows

Page 10

Credit risk premia moderated during the


quarter supported by central banks push
1Q15 Change Credit Default Swaps

BBVA Risk Premia Change Map

(% change in risk premia, shades represent last quarter change)

(as % MoM change in 5Y CDS. Darker color stand for positive or higher risk premia
Source: BBVA Research)

Source: BBVA Research)


-100.0

Asia

LATAM

EM Eur

Western Europe

G4

2009
USA
Japan
Canada
UK
Sweeden
Norway
Denmark
Finland
Germany
Austria
Netherlands
France
Belgium
Italy
Spain
Ireland
Portugal
Greece
Poland
Czech Rep
Hungary
Turkey
Russia
Mexico
Brazil
Chile
Colombia
Peru
Peru
Argentina
China
India
India
Korea
Thailand
Indonesia
Philippines
Hong Kong
Singapore

2011

2012

2013

2014

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
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# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
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2015

-50.0

0.0

50.0

100.0

USA
Japan
Canada
UK
Sweeden
Norway
Denmark
Finland
Germany
Austria
Netherlands
France
Belgium
Italy
Spain
Ireland
Portugal
Greece
Poland
Czech Rep
Hungary
Turkey
Russia
Mexico
Brazil
Chile
Colombia
Peru
Argentina
China
India
Korea
Thailand
Indonesia
Philippines
Hong Kong

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

Increase
<+25%

2010

Decrease
0%

-25%>

BBVA Research Risk Premia Map*


The Credit Risk Map show the monthly change in % of 5yr. CD Swaps
Darker / lighter colors mean sharper increases / decreases of CDS
Page 11

This moderation in risk aversion was not only


seen in the price of risk (CDs) but also
reflected in our Safe Haven index
BBVA Research Safe Haven Indicator

EMs change in risk premia

(Median Safe Haven Factor (2nd) from flows and asset prices data using the
BBVA DFM/FAVAR Model) Source: BBVA Research

30

15
10

Global/Regional

EM TOTAL

Extreme

20

Local

Bernanke Tapering

25

Draghi&QE

(Median EM 5Y CDS MoM % change)


Source: BBVA Research

0
-5

High

-10
-20

2012

2013

2014

2015

Below
Normal Normal

-15

0
-1

15%

30%

35%
70%

65%

85%

-2
2005

2007

2009

2011

2013

2015

BBVA Safe Haven Indicator


Represents the median of the selected safe haven components in portfolio flows, risk
premia and FX data

As well as some EM risk premia,


particularly EM Europe
CDS and equilibrium risk premium
(Source: BBVA Research, Equilibrium: average of four alternative models + 0.5 standard deviation)

Emerging Europe

Emerging Asia

LatAm

500

500

450

450

400

400

350

350

300

300

250

250

200

200

150

150

150

100

100

100

50

50

50

0
2009 2010 2011 2012 2013 2014 2015

Equilibrium range

0
2009 2010 2011 2012 2013 2014 2015

500
450
400
350
300

250
200

0
2009 2010 2011 2012 2013 2014 2015

The USD appreciates across the board. Euro


is further depreciated by the ECB policy
while some EMs suffer
BBVA Exchange Rate Map

FX 1Q15 average change in %

Asia

LATAM

EM Eur

Western Europe
G4

(Monthly variation of exchange rates vs. USD in %. Darker is depreciation)

2009
Switzerland
Japan
Canada
UK
Sweeden
Norway
Denmark
EuroZone
Poland
Czech Rep
Hungary
Turkey
Russia
Mexico
Brazil
Chile
Colombia
Peru
Peru
Argentina
China
India
India
Korea
Thailand
Indonesia
Philippines
Hong Kong
Singapore

###
###
0,50
1,20
3,00

2010

2011

2012

2013

(shades are last quarters average FX change)

2014

2015

####### ##################################################### ###### #########


####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########

Divergent monetary
policies among
DMs trigger euro
depreciation.
Pegged currencies
suffer

####### ##################################################### ###### #########


####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########

####### ##################################################### ###### #########


####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########
####### ##################################################### ###### #########

Strong Currency Depreciation (between -3 % and -6 %)


Moderate Currency Depreciation (between 0 and -3 %)
Moderate Currency Apreciation (between 0 and 3 %)
Strong Currency Apreciation (between 3 % and 6 %)
Sharp Currency Apreciation (greater than 6 %)

-20.0

-10.0

0.0

10.0

Switzerland
Japan
Canada
UK
Sweeden
Norway
Denmark
EuroZone
Czech Rep
Hungary
Turkey
Russia
Mexico

####### ##################################################### ###### #########


####### ##################################################### ###### #########

-30.0

Poland

EMs euro-block
currencies
depreciated

####### ##################################################### ###### #########


####### ##################################################### ###### #########

-40.0

Dollar orbit
currencies EMs
(LatAm & Asia)
suffered
expectations
about the impact
of ultra-lax Fed
policy

Brazil
Chile
Colombia
Peru
Argentina
China
India
Korea
Thailand
Indonesia
Philippines
Hong Kong
Singapore

BBVA Research Exchange Rate Map


(Darker Zones are negative variations but here it means depreciations)

Page 14

Currencies depreciates across the board but


due to different factors: local in Eurozone,
global in Emerging Markets
FX Change Decomposition in Developed and Emerging Markets
(in % MoM change, negative are depreciations)
Source: BBVA Research

Eurozone (Euro)
4

Emerging Markets*

0
0
-2
-2
-4
-4

Local

-6

Global
Local

Global

FX Emerging

FX Eurozone

-8

2012

2013

-6

2014

2015

2012

2013

2014

2015

(*) Measured as median % MoM change from the following Emerging


Economies; Turkey, Poland Czech. Rep., Hungary, Russia
South Africa, Mexico, Brazil, Chile, Colombia, Argentina, Peru, China, Korea,
Thailand, India, Indonesia, Philippines, Hong Kong, Singapore
Page 15

Low yields and ample liquidity boosted equity


indices. The strong USD weighed on US
equity indices as it constrains margins
Equity price changes (% QoQ)

BBVA Equity Price Map

(shades are last quarters QoQ change)

(Monthly Variation of Equity Price Indexes in %)

Asia

LATAM

EM Eur

Western Europe

G4

2009

###
###
###
0,50
1,20
3,00

USA
Japan
Canada
UK
Sweeden
Norway
Denmark
Finland
Germany
Austria
Netherlands
France
Belgium
Italy
Spain
Ireland
Portugal
Greece
Poland
Czech Rep
Hungary
Turkey
Russia
Mexico
Brazil
Chile
Colombia
Peru
Peru
Argentina
China
India
India
Korea
Thailand
Indonesia
Philippines
Hong Kong
Singapore

2010

2011

2012

2013

2014

2015

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

USD appreciation
compresses euro
-pegged margins

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

ECB QE -dominant
region favoured by
ultra-low earnings
discount rates

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

Sharp Equity Price Contraction (below -6 %)


Strong Equity Price Contraction (between -3 % and -6 %)
Moderate Equity Price Contraction (between 0 and -3 %)
Moderate Equity Price Expansion (between 0 and 3 %)
Strong Equity Price Expansion (between 3 % and 6 %)
Booming Equity Price Expansion (greater than 6 %)

EMs margins
compressed by
USD appreciation
and weaker
expected
earnings in line
with economic
performance

-40.0

-20.0

0.0

20.0

40.0

USA
Japan
Canada
UK
Sweeden
Norway
Denmark
Finland
Germany
Austria
Netherlands
France
Belgium
Italy
Spain
Ireland
Portugal
Greece
Poland
Czech Rep
Hungary
Turkey
Russia
Mexico
Brazil
Chile
Colombia
Peru
Argentina
China
India
Korea
Thailand
Indonesia
Philippines
Hong Kong
Singapore

Page 16

Expectations on economic policy favour


market discrimination for DMs against EMs
BBVA Assessing Equity Market Misalignment Composite Indicator
(Weighted average, of PER 12Forward, PER12T and P/B Ratios)

EM Asia

LATAM

EM Europe

Western Europe

G4

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
US
Japan
Canada
UK
Europe
EMU
Denmark
Netherlands
Germany
France
Italy
Belgium
Greece
Spain
Ireland
Portugal
Turkey
Poland
Czech Rep
Hungary
Romania
Russia
Mexico
Brazil
Chile
Colombia
Argentina
Peru
China
Korea
Thailand
India
Indonesia
Malaysia
Philippines
Hong Kong
Singapore

2014

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

# # # # # # # # # # # # # # # # # # # # # # #

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

# # # # # # # # # # # # # # #

2015

DM equities moving from neutral to


overvaluation given the monetary
policy push by central banks and
search for yield strategies.
Investors remain confident in the
effectiveness of DM economic
policies

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
#

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # #

# #

#
# #

# # # # # #

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

# # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # #

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # #

# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
# # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

EM equities corrections back


valuations to fair. Diminishing
earnings expectations and the
effects of monetary policy
normalisation suggesting equity
risk premia will remain high

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #
### # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # # #

Undervaluation

Overvaluation

Page 17

Scenarios
Simulation analysis
Page 18

The current Baseline Scenario is framed within


a set of possible macro & policy scenarios

(1) Baseline Market & macro scenario


Source: BBVA Research FAVAR Model

(2) Positive market & macro Scenario (3) Negative market & macro scenario
Source: BBVA Research FAVAR Model

(ource: BBVA Research

FAVAR Model

Global growth

Global growth

Global growth

Global growth to narrow 3.6% in 2015 thanks to


the US. DM to grow close to 2.3% in 2015, EMs to
remain subpar and growing at 4.5% in 2015

Global growth surprises to the


upside but not enough to trigger
earlier normalisation

Global growth divergence with


DMs outperforming and EMs
worsening

Global monetary policy

Global monetary
policy

Global monetary
policy

US MP normalisation to start in 2Q15 will push term


premia in DMs, spread to EMs will widen. US T bill to
reach 2.6% in 4Q15. Bund to reach 0.4 % in 4Q15

FED normalisation delayed. ECB


committed to current QE

US MP normalisation before
expectations (now mid-2Q) & market
overreaction

Global risk aversion

Global risk aversion

Global risk aversion

Global risk appetite remains


alive (VIX at lows and stable)

Global risk aversion


increases

Global risk aversion to slowly take off from current


current levels (VIX) but with decreasing negative
differential to EMs (EMBI)

Page 19

Contained shock consistent with our base


scenario for Portfolio Flows. Risk is still tilted to
the downside
Monetary Policy in the North & Flows impact in EMs
(Alternative QE FED & ECB scenarios on EM Flows)

Cumulative Response of Portfolio Flows in US bn, forecast made as 3Q-14)


Source: BBVA Research & IMF
1.00

(2) Positive Senario

(1) Baseline Scenario

(3) Negative Scenario


0.95
Data 3Q14
Now Cast 4Q14
NowCast/Fcast 1Q15

0.90

0.85
0.80

3
0.75

Page 20

0.70
0.65
0.60

2011

2012

2013

2014

2015

2016

2017

Initial positive reaction of EM flows


at 3Q14 (last official data) reversed at
the end of 2014
Some signs of volatility & overreaction
at the end of 2014 but flows now
anchored to our central scenario.

The risk is on the downside depending


on Feds normalization path

Hot Topic
Russian Woes
Page 21

Russian financial tensions similar to previous


crisis but local component of portfolio flows
recovering faster
Idiosyncratic bond flow reaction to
comparable FTI shock (1: Global Crisis 2009) Source:

Russian bond flows


Source: BBVA Research

BBVA Research
4

3
4

Median EM ITF path


2009 (dashed)

Median EM bond flow in


ITF path 2009

1
0
-1

Russia ITF Oct. 2015

Local
Global/Regional
Russia

-2

-2
Russia bond flow
Oct. 2014
(dashed)

-4
0

*In SD Deviations

-3
-4
5

10 11 12

2012

2013

2014

2015

Months after shock

** Median ITF dynamics in similar event as recorded from Jan 2009 for all
1H 2013 Bond Flow Cumulated Contraction: -10.3% (Global/Regional 65% Local 35%)
Emerging Markets standardized vs. Median Idiosyncratic component dynamics 1H 2015 Expected Cumulated Contraction: - 11% (Global/Regional 30% local 70%)
recorded during the financial stress episodes (only for EMBI markets)

Page 22

We should remain very vigilant as shocks to


Russian portfolio may translate to domestic
Europe through banking exposures
interconnectedness
Interbank interconnectedness in Europe 3Q14
(Nodal chart of interbank relations)
Source BIS Table 9B consolidated banking statistics as from 3Q14

Germany

According to official BIS data, we can find two interbank

European clusters: greater Western European countries


(creditors) and EM European borrowers (debtors). This
interconnectedness between East and West has remained stable
through time though with increasing intensity

France

The direct exposure to risky countries in EM Europe (Russia

UK

and Ukraine) are marked in red. It is significant for some


countries (i.e. Italy), but in general terms is well-diversified
and should not give rise to serious problems

However, we enter a more serious scenario if we move to the

rest of EM Europe (Czech Republic, Hungary, Poland,


Romania and Croatia). If the crisis reaches these countries (in
orange), important Western European creditors such as
Austria, Italy and Belgium (in orange) would be affected

This situation could become challenging. Although the indirect

NOTE: Node size is the size of each countrys banking system relative to the total. Lines are
assets/liabilities (credit financing outflows/inflows) and the colour tone corresponds to the origin of
the flow ,while the size of the lines is relative to these flows. Eastern European countries (apart
from Turkey) do not report assets.

exposure is less straightforward, it can be easily checked in the


graph on the left. Pivotal countries mentioned above would
move the exposure to key Western countries such as
Germany, France and the UK, which have the potential to
trigger more important risks to the European and the global
economies.
Page 23

Useful
Information
Page 24

Methodology and Interpreting the Results


A Dynamic Factor Model / Factor
Augmented VAR to analyze and forecast
flows and asset prices
Our framework is based on the belief that there are unobservable factors or channels that act at the global (GLOBAL), regional
(Developed (DM), Emerging (EM) and Safe Havens (SH) and idiosyncratic (I) transmitting from the global macro economy to flows or
asset prices. The origin of these shocks can be created due to monetary policy in DMs, expected growth differentials between DMs
and EMs and the differential risk aversion levels arising between the latter two.
To model the behavior between flows and asset prices and these global shocks via the described channels we use a two step
approach based on a Dynamic Factor Model (DFM) and its interaction to a Factor Augmented Vector Autorregresion (FAVAR)
In the first part of the model, the Dynamic Factor Model of Portfolio Flows and Asset Prices, we use a version of a Dynamic Factor
Model. Our set-up comprises a measurement equation block (1) and a state equation block (2). Both blocks together build the so
called State Space Model. In this, the measurement equation block relates each observable portfolio flow in the (Y) matrix to several
unobservable states or latent factors (F) with varying intensities according to the estimated parameters of each flow.
In the second part of the model the Factor Augmented VAR (FAVAR) model we state the relation of the extracted factors with a set
of macroeconomic variables in the form of a VAR structure allowing time dynamics between the three elements of the analysis:
factors, macro and flows/assets.
We have chosen a set of macro variables so that the extracted factors carry strong statistical relations to the global financial cycle
represented here with the EUR and US long-term rates that proxy the term premium. Also, factors and these latter variables carry
strong links to the Global Risk Aversion and the Differential Risk Aversion to Emerging Markets (here gathered with the VIX and the
EMBI respectively as in Rey 2012). Lastly we have analysed the relation of these variables and variables that proxy growth and
growth differentials between developed and emerging markets (here as the G7 and great -EM median GDP Q/Q growth rates).

The model is estimated by means of maximum likelihood with Bayesian techniques and a prior that leverages more in the recent past
in order to gauge the recent events.
Factors are forecasted conditional to the evolution of macro economic variables following the scenarios described bellow and flows
are recovered back from the forecasted factors by means of the estimated measurement equation block (1) described above.
Page 25

The BBVA_PM: a two step DFM/FAVAR model


(1) The Dynamic Factor Model (DFM) to
extract flows (and asset prices) factors

(2) Factor Augmented Model (FAVAR) to combine


Macroeconomic variables and factors and Variables

1 Measurement Block Relates Factors (Ft) and Flows (Xt)

2) Transition Block allows for flows (Ft) dynamics as AR

The Noise to Signal Ratio is maximized, errors are iid.


The process is estimated using a Kalman Filter

Flows assumed to conceal a structure of latent factors


(L) (Global, Regional and Idiosyncratic), Each factor is
orthogonal and follows an AR(p) process (f(L)).
PF(t)i=b1i*Global(t)+b2i*EME(t) +bi*IDIO(t)i+U(t) (emerging)

Exploiting time relations between the extracted latent


factors and a set of selected global macro variables (2) and
recovering flows by means of the measurement equation
block in the DFM.

Global &
Regional
Macro
Shocks

Transmission
Channels
(Macro &
Factors)

From
Factors
To Fin.
Variables

PF(t)j=b1j*Global(t)+b4i*DME(t) +bi*IDIO(t)i+U(t) (developed)


PF(t)j=b1j*Global(t)+ b4i*DME(t) ++b5i*SH(t) + bi*IDIO(t)i+U(t) (SH)
* See Doz, Giannone, Reichlin (2006), Watson, Reis (2010), Agrippino and Rey, H. (2013) Fratzscher 2013, Rey (2012),
Puy (2013) among others

SHOCK
Risk Aversion ( VIX /EMBI)
Monetary Policy (Fed,
ECB rates)
Growth differentials

TRANSMISSION
To Global the Global
factor
To Specific Markets
(DM,EM, SH)

REACTION
Retrenchment
Reallocation
Flight to
Quality
etc.

26

BBVA Research
Group Chief Economist
Jorge Sicilia
Emerging Economies:
Alicia Garca-Herrero
alicia.garcia-herrero@bbva.com.hk
Cross-Country Emerging Markets Analysis
lvaro Ortiz Vidal-Abarca
alvaro.ortiz@bbva.com
Asia
Stephen Schwartz
stephen.schwartz@bbva.com.hk
Mexico
Carlos Serrano
carlos.serrano@bbva.com
Latam Coordination
Juan Ruiz
juan.ruiz@bbva.com
Argentina
Gloria Sorensen
gsorensen@bbva.com
Chile
Jorge Selaive
jselaive@bbva.com
Colombia
Juana Tllez
juana.tellez@bbva.com
Peru
Hugo Perea
hperea@bbva.com
Venezuela
Oswaldo Lpez
oswaldo.lopez@bbva.com

Developed Economies:
Rafael Domnech
r.domenech@bbva.com
Spain
Miguel Cardoso
miguel.cardoso@bbva.com
Europe
Miguel Jimnez
mjimenezg@bbva.com
US
Nathaniel Karp
nathaniel.karp@bbvacompass.com

Global Areas:
Financial Scenarios
Sonsoles Castillo
s.castillo@bbva.com
Economic Scenarios
Julin Cubero
juan.cubero@bbva.com

Financial Systems & Regulation:


Santiago Fernndez de Lis
sfernandezdelis@grupobbva.com
Financial Systems
Ana Rubio
arubiog@bbva.com
Financial Inclusion
David Tuesta
david.tuesta@bbva.com
Regulation and Public Policies
Mara Abascal
maria.abascal@bbva.com
Recovery and Resolution Policy
Jos Carlos Pardo
josecarlos.pardo@bbva.com

Innovation & Processes


Oscar de las Peas
oscar.delaspenas@bbva.com

Contact details:
BBVA Research
Paseo Castellana, 81 7th floor
28046 Madrid (Spain)
Tel. + 34 91 374 60 00 and + 34 91 537 70 00
Fax. +34 91 374 30 25
bbvaresearch@bbva.com
www.bbvaresearch.com

BBVA Research Asia


43/F Two International Finance Centre
8 Finance Street Central
Hong Kong
Tel: +852 2582 3111
E-mail: research.emergingmarkets@bbva.com.hk

Page 27

Disclaimer
This document, prepared by BBVA Research Department, is provided for information purposes only and expresses data,
opinions or estimates pertinent on the date of issue of the report, prepared by BBVA or obtained from or based on sources we
consider to be reliable, which have not been independently verified by BBVA. Therefore, BBVA offers no warranty, either
express or implicit, regarding its accuracy, integrity or correctness.
Estimates this document may contain have been undertaken according to generally accepted methodologies and should be
considered as forecasts or projections. Results obtained in the past, either positive or negative, are no guarantee of future
performance.
This document and its contents are subject to changes without prior notice depending on variables such as the economic
context or market fluctuations. BBVA is not responsible for updating these contents or for giving notice of such changes.
BBVA accepts no liability for any loss, direct or indirect, that may result from the use of this document or its contents.
This document and its contents do not constitute an offer, invitation or solicitation to purchase, divest or enter into any interest
in financial assets or instruments. Neither shall this document nor its contents form the basis of any contract, commitment or
decision of any kind.
With particular regard to investment in financial assets having a relation with the economic variables this document may cover,
readers should be aware that under no circumstances should they base their investment decisions on the information contained
in this document. Persons or entities offering investment products to these potential investors are legally required to provide the
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communication, making available, extraction, reuse, forwarding or use of any nature, by any means or process, are not
permitted except in cases where it is legally permitted or expressly authorised by BBVA.

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