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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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If you're a "glass half full" type, things might be looking a bit brighter for emerging markets .....

January 15, 2019

 

ref :- "For emerging markets, a more fearful Fed is a less frightful one", The Economist

 

There is no truth in the suggestion that we're looking at an emerging markets article merely to avoid the impossible mess that is Brexit, and the UK parliament's vote on PM Theresa May's deal tonight .....

 

Oh all right then, there's a lot of truth in it .....  it really has come to something when losing a parliamentary vote by less than 100 would be seen as a right result for the government (estimates range from a loss by 60 seats to 200). We'd rather not speculate on the outcome, or on the vast range of ramifications, and therefore market reactions, that might result from it. Too extreme and probably something that even the wilder speculators should probably steer clear of ..... so emerging markets it is, then.

 

The Economist begins by reminding us of an awkward "catch 22" faced by emerging nations in the relationship with the U.S. On the one hand, the US is such an important market for their goods that if the US economy slows up, so does demand for their exports. On the other, if the US forges ahead then the Federal Reserve is likely to put up interest rates and thus lessen demand for EM assets.

 

Last year was a classic example ..... a US economy that was already performing strongly was given the kind of shot-in-the-arm favoured by 1980's weightlifters by the Trump administration's package of tax cuts and increased spending. Leaving aside the question of whether such stimulus was appropriate or not, the Fed felt compelled to hike rates four times to forestall the inflationary threat that a rampant economy might provoke. These rate hikes caused a sharp reduction in the value of EM currencies that were already overvalued against the dollar and were a blow in the solar plexus to all EM borrowers who had piled into dollar-denominated debt when rates were so low.

 

Investors may have been distressed by the late reversal inequities that made the year-on-year performance of US equities in 2018 rather more dismal than looked likely but spare a thought for investors in EM equities. The MSCI index of EM equities dropped by a fraction less than 17% last year.

 

Nasty .... but EM investors will be encouraged by the start of 2019. Fed Chairman Powell and other officials have introduced a newly doveish element to their rhetoric, an acknowledgement of the recent stock market volatility and of the stuttering performance of the global economy. Perhaps more to the point, Powell has called inflation "muted" and stressed that the Fed will be "data-dependent" when deciding policy. Having long projected three more hikes for 2019, the last Fed dot-plot reined backed their expectations to two .... which most market players think is still highly unlikely. At the very least a pause seems likely, and futures markets are trading at levels that reflect that NO hikes are more likely than even one in 2019.

 

So it's just as well Powell has also been reminding us of how "nimble" the Fed can be when conditions demand it ..... like in 2016, for instance. Then, it started the year by forecasting four rate hikes but changing circumstances (particularly outside of the US) meant they delivered only one. Not at all coincidentally, EM shares rose 9% in 2016.

 

The question is, can we look for something similar this year? One argument for believing so is that the worst may already be behind us. Currencies have already devalued and trade gaps have narrowed (think Turkey). And for those happy to take that "glass half full" view of things, the Economist suggests that there are encouraging signs on the US / China trade front. Could it be that the end-of-year ructions in the US stock markets, particularly in the all-important technology sector, will cause Mr Trump to tread a little more cautiously?

 

Mmm .... as strategies go, banking on a "softly, softly" approach from the White House seems a little unreliable. Besides, there are other dangers. One is the danger of the markets reading too much into the more dovish Fedspeak of late. They may not expect any hikes in 2019, but officially the Fed still expects to raise rates twice. If they even did it once, what would be the reaction of markets that had grown accustomed to believing it wasn't going to happen /

 

Another danger lies in the degree of any US slowdown. If that's all it is, and it causes a more doveish approach from the Fed, well ..... that's just fine for emerging markets. But if the Fed has to come over all doveish because the economy is genuinely faltering, that BAD for emerging markets. The same could be said of the effects on demand of a faltering Chinese economy ..... and the danger of that does seem very real.

 

We might concentrate on US rates and their global effect, but at the end of the day, the key factor for EMs may be the performance of China's economy. Of course, US rates have a big bearing on that in a number of ways, but the biggest factor right at this moment may be trade conflict. If you believe that a relatively quick and amicable resolution is possible, there are reasons for optimism.

 

So, is your glass half full, or half empty?

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