April 30, 2018//-Emerging market (EM) economies are powering ahead in 2018, despite higher rates, market volatility, and rising fears of protectionism.
We spoke to Andrew Tilton and Kamakshya Trivedi, co-authors of GS Research’s EM Macro Navigator report, to better understand the resiliency and why tariffs are unlikely to derail the growth story.
Andrew, you’ve said that even as activity continues to pick up in EM economies, there is still “room to grow.” What is contributing to this?
Andrew Tilton: Robust global trade growth and above-trend growth in developed markets over the past couple of years has been a boon for emerging markets. Barring the recent market volatility, the global backdrop has facilitated EM expansion, and we believe there will be only a gradual fading of this external impulse.
Output gaps remain in many EMs, and inflation pressure is generally modest so policy tightening can be gradual. Apart from this, the resilience in EM economies and asset markets also reflects favorable cyclical dynamics — many are still early cycle relative to their developed peers.
How should the various EM asset classes be looked at in this overall constructive stance?
Kamakshya Trivedi: They’re not as undervalued as they were in early 2016 or 2017, but prices are generally at undemanding levels and we expect them to move higher through the year on the back of favorable global and local macro dynamics.
After a very strong start to the year, EM assets have come under pressure as US rates and the Dollar have moved higher and global equities have seen a drawdown.
But overall they have traded resiliently–EM equities have so far weathered the recent spike in volatility, EM local rates have outperformed the move in Dollar rates and EM FX has traded in line with the rest of G10 FX.
Credit has been the weakest link, but even the trajectory for that is still broadly in line with the spread widening seen in US corporate credit. We also feel that the ongoing volatility is re-creating pockets of value.
More recently, trade tensions have rattled markets. What’s your take on the impact of the proposals for EMs specifically?
AT: We feel trade tensions pose more market than economic risk for now, and actual US trade sanctions in 2018 will be less dramatic than the rhetoric. While trade tensions between the US and China are unlikely to be fully resolved in the near-term, and further escalation remains a concern, we think any hit to East Asian growth will be small. We are also cautiously optimistic for a resolution on NAFTA before the Mexican election this summer.
KT: Paradoxically, part of the solution to the trade tensions may involve moderately stronger rather than weaker currencies in EMs running large current account surpluses.
So what could go wrong for EMs?
AT: We’re focused on risks in three areas. Political risks could escalate and threaten the relatively benign macro-markets picture. In addition to the current concerns over trade protectionism, there are important elections later this year in a number of EMs, and the outcomes may not necessarily be market friendly.
Secondly, an acceleration in Fed rate hikes that pushes the Dollar meaningfully stronger would challenge the Goldilocks EM story of the past couple of years. A policy-driven slowdown in China would also clearly have material spillovers to EM Asia and beyond. But presently, none of these risks rise to the level of a red flag for the EM growth story.
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