Emerging market asset returns were more muted in April. Hard currency sovereign and corporate bonds rose by 0.24% and 0.78% respectively. However, given the stronger US dollar, local currency emerging market debt fell by 0.18% in April.
The European Central Bank followed in the US Federal Reserve’s footsteps, becoming more dovish. And the global growth backdrop took a positive turn: stronger than expected economic data from the US helped to lift sentiment, although the resultant strength of the US dollar weighed on some emerging market currencies; Asian countries also posted improved economic activity data, with China reporting expectations-beating GDP growth and providing other positive data surprises. We see the latter as further evidence of the effectiveness of China’s stimulus measures, confirming the view we heard in Washington during this year’s World Bank/IMF Spring Meetings. Russia also posted encouraging growth data which beat consensus expectations.
The US government’s decision to remove waivers from sanctions relating to Iranian crude oil purchases pushed up oil prices, helping oil-sensitive assets, particularly in credit markets.
Moody’s upgraded Egypt’s sovereign credit rating during the month, citing the country’s progress on ongoing reforms and their positive implications for the economy’s health and future growth. The Philippines also saw its credit rating upgraded (by S&P to BBB+) in recognition of its strong and diversified GDP growth and early successes in recent tax reforms.
In contrast, weakness continued in Turkish assets. While the central bank kept rates on hold as expected, its policy statement took a less hawkish tone which surprised the market and raised serious questions, once again, on its ability to tackle the crisis.
In Latin America, some pockets of strength were overshadowed by negative headlines, particularly from Argentina. Concerns over the potential for a populist presidential election result in October intensified, weighing heavily on sentiment. Polls indicated that incumbent President Macri’s policies have lost some support and that his left-wing opponent Cristina Fernández de Kirchner gained ground. In Brazil, ongoing concerns around pension reforms weighed on asset prices. While in Colombia, the central bank shifted to a more dovish stance and although rating agency Fitch expressed disappointment in the country’s fiscal adjustments, it noted that growth has picked up – an observation backed up by various data releases.
Our general outlook for emerging market fundamentals remains relatively positive, leading us to maintain our overall risk exposure at slightly overweight.
The backdrop remains relatively constructive, with recent data releases pointing to a bottoming in macro indicators in key developed and emerging economies. At the same time, the shift to a more dovish monetary policy stance in major markets such as the US and the Eurozone continues to provide support for risk sentiment.
However, the prospects for the US-China trade negotiations have clearly worsened. While our base expectation remains that a deal will be struck eventually, recent developments have re introduced a greater degree of uncertainty around this. If the situation continues to escalate this could undermine expectations of an improvement in global business sentiment and hence global growth into the second half of the year.
While this increases uncertainty over the near term, over the medium-term we still believe emerging economies have the potential to pick up and outperform developed market economies. Emerging markets on aggregate are early in the cycle with plenty of slack in many economies. This provides room for growth to accelerate without stoking inflation or causing a deterioration in trade balances.
The shift to a more dovish monetary policy stance in major markets continues to support sentiment
Tactically, we remain slightly overweight risk given our view that the growth tide is turning and with valuations continuing to appear attractive in parts of the market.
We remain overweight emerging market currencies as valuations appear relatively attractive on a real effective exchange rate basis (REER: inflation-adjusted currency valuations) and as signs of global – and emerging market – growth bottoming out suggests further upside potential.
We also remain positive on US dollar debt as spreads/cash yields remain attractive and credit quality is improving at margins. In contrast, we are neutral in local bonds where asset prices seem to already reflect an outlook of low inflation and the term premium on offer to investors is relatively low.
*Keep an eye on our Emerging Perspectives page for forthcoming insights.
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Some common threads exist in the richly-diverse emerging market tapestry. And these can provide valuable, if rather unexpected, insights for investors.
Take Turkey – a country hitting the headlines for all the wrong reasons. Recent discussions among our regional experts have uncovered interesting parallels between it and three countries in Latin America: Brazil, Argentina and Venezuela. The journeys of these range from an impressive turnaround story to a tragic demise. Which, if any, Turkey ends up emulating is of crucial importance to emerging market debt investors given Turkey’s significant index weight.
In the early 2000’s Turkey was tipped as a potential future member of the European Union. What followed was a golden decade which lifted many Turkish citizens above the poverty line. But more recent years have seen Turkey follow an altogether different path, with a slow but sure erosion of institutional credibility and years of economic mismanagement.
It is easy to forget that Erdogan’s government was initially heralded as the pragmatic new market-friendly regime. Where a leader sits on the “pragmatic to ideological/populist” spectrum is a key consideration for us as emerging market debt investors, as we outlined recently in a piece on Mexico.
Over his three terms in office, the Erdogan government’s positioning on this scale has moved in a worrying direction, as the chart below starkly reveals. This has translated to a gradual erosion of institutional strength and increased autocracy in Turkey.
We had hoped that on his re-election last year Erdogan would appoint a relatively pragmatic government and thus return the country to the path of structural reform and more orthodox policy making. Instead, he installed his son-in-law as finance minister, published a decree that would have far-reaching ramifications for the country’s institutions and increased presidential control over the central bank.
Developments in recent weeks have brought political and economic concerns to a head, with suspected pre-election currency market interference, the incumbent government’s refusal to accept defeat in Istanbul and weak efforts to stem the tide of domestic money being converted into US dollars.
Turkey’s rise in authoritarianism and the resultant clampdown on opposition, personal and press freedom raises the risk of painful economic sanctions and is heightening the concerns of market participants. With no natural resources to ameliorate or mask the structural weakening of the economy, where next for troubled Turkey?
While historic comparisons are never perfect, a look at Latin America reveals some interesting parallels to the prevailing economic and political environment in Turkey. An imminent democratic changing of the guard, à la Brazil, seems unlikely. Fortunately, we also think it is unlikely, for now, that Turkey descends to the lows of Venezuela. As the most relevant comparison may be an Argentina-like degradation over a number of years, we remain cautiously positioned in in local currency Turkish assets across our emerging market debt strategies.
Keep an eye on our Emerging Perspectives page for the full paper on this topic.
Source: Hawkins, Kirk A., Rosario Aguilar, Erin Jenne, Bojana Kocijan, Cristóbal Rovira Kaltwasser, Bruno Castanho Silva. 2019. Global Populism Database: Populism Dataset for Leaders 1.0. Available for download at populism.byu.edu
Grant Webster, Portfolio Manager & Vivienne Taberer, Portfolio Manager
Despite trade-related headwinds, Chinese growth data painted a picture of resilience in the domestic services and consumer sectors. Overall, first quarter GDP growth slightly beat expectations to print at 6.4%. We expect this domestic strength to persist, helped by VAT rate cuts, which came into effect at the start of April.
Given these positive growth dynamics and China’s policy preference for currency stability to bolster the chances of a deal with the US, we think that the Chinese renminbi has the potential to outperform. Therefore, we have added to our overweight position in the currency.
Early in the month, concerns that Malaysian government bonds could be dropped from the WGBI index triggered outflows. The market also priced in a high chance of an interest rate cut in the next 12 months. We disagreed with this view given that domestic growth is fairly steady and we expect inflation to move higher, making a rate cut unlikely (rates and bond prices are inversely related). Therefore, we moved to an underweight position in unhedged local Malaysian bonds.
Despite trade-related headwinds, Chinese growth data painted a picture of resilience
The elections in Thailand went smoothly, but uncertainty remains over who will make up the next government. We moved underweight Thai rates as we believe growth is fairly steady and rates are significantly overvalued.
Elsewhere, Indian purchasing managers’ index data was a bit weaker than the previous month, with eyes now on the elections. Korea’s central bank left interest rates on hold, as expected and it revised growth forecasts and inflation slightly lower. The Philippines saw its credit rating upgraded by S&P to BBB+, in recognition of its strong and diversified GDP growth and early successes in recent tax reforms.
The outlook in Latin America became more mixed in April and in turn this reflected in our positioning: we cut our overweight in the Colombian peso and reintroduced our underweight position in the Chilean peso.
Argentina had a weak month in investment markets despite the IMF board approving the disbursement of almost 11 billion dollars early in the month. Falls in US dollar deposits pushed up the currency, but this was overshadowed by lots of noise around the election weighing on investors sentiment (increased fears over a shift back to a populist regime). We believe the hard currency bond market is pricing in a 60% probability of Cristina Fernández de Kirchner winning the election in October. However, with the currency now more stable following recent policy changes, and inflation expected to moderate, we believe that this risk premium is excessive.
In Brazil, services and composite purchasing managers’ index data came in at the strongest level in recent years. The successful auction of six ports raised more than expected, which is a positive for the country’s fiscal balance. Noise around pension reform has continued to spook markets. This has now begun to dissipate, and we remain optimistic that the reform will pass through Congress in the third quarter.
The Chilean peso tested the top of its recent trading range; there was positive momentum around the pension reform, reasonable economic activity and higher copper prices.
Meanwhile in Colombia, rating agency Fitch said the country’s fiscal adjustment has been disappointing, but it also noted the pick-up in activity. Interest rates are on hold and the central bank remains dovish, while there are signs of improvement in growth and economic activity.
The Venezuelan crisis intensified with the opposition appearing to be losing momentum despite its attempts to topple the current political regime. International pressure continues to mount, with the IMF announcing that the country no longer has access to a standby facility.
In Mexico, noise continued from US President Trump regarding car tariffs, with the Congress and Senate passing the requisite labour reforms for USMCA (US-Mexico-Canada agreement). Inflation printed a lot higher than expected, which will likely push a rate cutting cycle further into the future, despite the economy continuing to show signs of slowing.
In Africa, we continue to maintain our views from March and made no changes to our positions over April.
Ghana posted strong GDP growth data for the final quarter of last year, reinforcing our positive view on the country.
Egypt’s positive economic momentum also continued, with inflation continuing to fall. And the country saw a rating upgrade from Moody’s, which we believe is well-deserved. This is a frontier market that we have high conviction in.
Despite rather disappointing economic data from the Eurozone, Central European economies continue to perform strongly on the back of tight labour markets and rising incomes as well as loose monetary and fiscal policies.
In Hungary, there are few signs of a slowdown. Rebounding retail sales and strong industrial output point to another strong quarter, while inflation pressures intensified further. However, we exited our overweight position in the Hungarian forint following the unexpected dovish message by the Hungarian central bank, a policy mistake in our view.
In Poland inflation accelerated sharply in April, well above market expectations but is unlikely to trigger a reaction by the Polish National Bank, in our view. We maintain an underweight position in Polish bonds. In contrast, in line with our expectations the Czech Republic’s central bank responded to persistent inflationary pressures by raising policy rates once again despite revising lower its growth expectations for next year, further cementing its credibility as an independent inflation-targeting institution.
In Romania, the substantial increase in public-sector wages at the beginning of the year led to very strong retail sales and, in turn, to a further widening of the trade deficit and inflation surprising to the upside. We see risks of further monetary policy tightening and maintain our underweight position in Romanian assets. In Serbia, Minister of Finance Siniša Mali confirmed, during our meeting in London, the government’s commitment to the long term fiscal targets: a) aiming for a 50% public debt/GDP; b) maintaining a sustainable deficit of 0.5% of GDP and importantly increasing the share of public capital expenditure from 4.2% of GDP to 6% in areas such as health and the environment.
In terms of sovereign credit markets in the region, we maintain our overweight exposure in our high conviction markets including Hungary, Croatia, Serbia and Georgia – these positions are funded out of underweight positions in Romania and Poland.
In South Africa, although it was very much our expectation, the market responded positively to Moody’s decision not to downgrade. We remain cautiously positioned in the country. Business confidence continued to fall and the data for March painted a bleak picture. We now expect a sharp drop in quarter-on-quarter GDP growth to come through in the first quarter figures. Furthermore, inflation has continued to surprise to the downside given benign food prices, as retailers have struggled to pass on higher costs, despite retail sales being slightly stronger than expected. And consumer confidence has continued to fall, although it is still stronger than in 2016 and 2017.
Weakness continued in Turkish assets. While the central bank kept rates on hold as expected, its policy statement took a less hawkish tone which surprised the market and raised serious questions, once again, on its ability to tackle the crisis. We remain cautiously positioned.
Russia saw a surprise in growth data again. There was also a big rise in net exports given the decent oil price and good volumes, with imports significantly lower. We added to our position through bond auctions which were well supported by foreign demand, which continued through the month. Purchasing Managers’ Index data improved from a low level with output orders rising.
In the Middle East, the news of the US withdrawal of Iranian waivers (the US putting an end to exemptions from sanctions for countries still buying Iranian oil), was met positively, if cautiously, by key Gulf policymakers.
We expect Saudi Arabian officials to be cautious in increasing production given recent experiences as well as within the wider context of the OPEC+ production curtailments.
Despite Saudi Arabia’s lower oil production in the first quarter, the country managed to post a budget surplus – though this was principally due to a special dividend from Saudi Arabian oil company (Aramco) and seasonally low spending; we expect the fiscal trajectory to weaken over the rest of this year. Therefore, in the investment-grade space we continue to prefer Qatar where we see value given its low fiscal and external break-evens.
In high yield space, we exited our position in Oman after it rallied on the back of oil price gains. The rally left valuations stretched, in our view, given the country’s financing requirements remain high for 2019, as well as more structural issues around its fiscal trajectory. We retain an overweight exposure to Jordan, which remains well supported by the international community and committed to its IMF programme – which has been extended while a new programme is discussed.