EM growth and exports should continue to benefit from slow but steady growth in developed countries and expanding world trade volumes, although at some point we expect the US economy could decelerate to a slower pace as monetary tightening takes hold. Subdued underlying money and credit growth in many EM countries means that inflationary pressures from recent currency devaluations should be temporary, and most central
banks can afford to let floating currencies act as an adjustment mechanism. Most countries with current account deficits have tightened policies, which should help foreign reserves to stabilise going forward.
Sanctions against Iran should bolster crude oil prices, and it seems that “OPEC+” has a reduced ability to fully plug the resulting supply shortfall, thus underpinning energy prices. In China, the policy of “regulatory tightening” has been replaced by a more aggressive “monetary loosening” along with fiscal measures to boost consumption and support private companies facing difficulties from the impact of the trade war. Infrastructure investment is still languishing. The US “trade war” with China will most likely continue, and even escalate next year we believe. This scenario is now more fully priced-in to markets, and participants are watching closely for evidence of an impact on growth and/or inflation. As the recent deal with Mexico and Canada shows, benign outcomes are still possible under the Trump presidency.
The Fed’s balance sheet is now shrinking by more than $30bn per month, and the European Central Bank’s QE programme will cease by year-end. This will sustain pressure on those countries more dependent on global capital flows to fund fiscal and external deficits. Nonetheless, the key Central Banks’ policy rates remain very low in real terms, supporting the search for yield, and hence EM debt from a technical perspective. Going forward, any further pick-up in global market volatility and/or a US slowdown could be met by a dovish tilt from the Fed that would support EM assets. EM sovereign issuance has already reached $132bn year-todate, so for most countries, financing needs have been met. EM bond fund flows are quiet, and we believe that global investors remain structurally under-allocated to EM credit. After recent spread widening in the high-yield segment, the
J.P. Morgan EMBI Diversified Index spread of 360bps is wide to the post-Lehman’s average, so valuations are attractive.
We see three main risks to the outlook. Unexpectedly strong price or wage inflation data in the US could accelerate Fed rate hikes, pushing up the USD and leading to a period of volatility for bond and equity markets. The imposition of a 25% tariff on a wider range of US imports from China could lead to a worsening in tensions, hitting confidence and investment expenditure in either (or both) economies. Finally, although not our base case, evidence of further weakness in the Chinese economy, and a weaker Renminbi, could hit global commodity prices and have knock-on effects in Asia and Latin America.
Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any products that may be mentioned.
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