The unpredictable novice in the White House is making emerging markets seem less dangerous by comparison, say strategists like Goldman Sachs Group Inc.’s Kamakshya Trivedi.
And that’s giving him the confidence to recommend buying local-currency assets in countries like Russia and Brazil, ignoring the wreckage of previous Federal Reserve tightening cycles.
With economies in the strongest position they’ve been in years to withstand higher U.S. interest rates, investors are counting on developing countries to keep offering big returns, and they’re skeptical U.S. President Donald Trump will deliver enough of his protectionist agenda to stand in their way.
“Investors are concerned about being underweight emerging markets if materially protectionist policies aren’t introduced and the rally continues,” Trivedi, Goldman’s chief emerging-market macro strategist in London, said by phone. “Emerging markets are in a better position to absorb our projection of three Federal Reserve rate hikes this year.”
It hasn’t been that long since the prospect for higher U.S. rates sent investors rushing for the exits. The MSCI Emerging Markets Index of equities slid 14 per cent in the month after then Fed Chairman Ben S. Bernanke first signaled in May 2013 that he’d start scaling back stimulus, and currencies tumbled for three years straight with the phasing out of easy money.
But as the Fed looks set to hike its benchmark to 1 per cent for the first time since 2008, asset managers are looking past the external risks because they like what’s going on inside emerging countries.
For one, as Brazil and Russia emerge from recessions, developing economies are poised to grow more than twice as fast as advanced nations this year. At no point since 2010 have more economic data out of emerging markets exceeded forecasts, according to a Citigroup Inc. surprise index.
Current-account deficits for South Africa, Brazil, Turkey, India and Indonesia are also less than half the size they were in 2013, when Morgan Stanley dubbed the group the Fragile Five for their vulnerability to outflows as the U.S. tightens policy.
Inflation, meanwhile, is at multi-year lows, giving investors in London or New York larger returns once consumer-price growth is stripped out. In Russia, the real rate on 10-year debt is 3.5 percent and in Brazil it’s 5.5 percent, compared with less than 1 percent in the U.S. and negative returns across the euro-area. With little upward pressure on longer-dated U.S. yields, emerging-market bonds will stay attractive, according to Goldman’s Trivedi.
“The Fed hiking cycle this year won’t have a violent impact on emerging markets compared with previous years,” said Dirk Willer, a New York-based emerging-market fixed-income analyst at Citigroup.
The proof is in the numbers: flows into bond funds that invest in developing nations jumped to a five-week high of $2.1 billion in the first week of March, according to data of fund-tracker EPFR Global. The MSCI equities gauge is having its best start to a year since 2012, while a gauge tracking 20 currencies is up 2 percent.
This doesn’t mean emerging markets will be unscathed by U.S. policy decisions. Even in the past month as odds for the Fed to hike in March soared from 30 per cent to a done deal, currencies in Colombia, Chile, Russia and Brazil slumped 1.3 per cent or more.
If Trump is able to get his policy agenda on track — including plans to tear up trade deals, discourage imports and spend more at home — the risk is that U.S. inflation gallops and the Fed raises rates faster than expected. That would undermine the case for chasing yields in developing nations.
Already, the premium an investor gets to hold emerging-market debt over Treasuries is near the smallest since 2014, at 310 basis points, according to a JPMorgan Chase & Co. index.
“A faster-than-expected pace of U.S. monetary tightening could trigger a shake-out in Treasuries and a selloff in emerging markets,” said Ben Sarano, a London-based money manager at hedge fund Emso Asset Management.
For now, this isn’t a prevailing worry. If anything, the broad-based improvement in global economies from Germany to China may cap gains in the dollar and support emerging-market currencies, which are showing nearly the smallest price swings since mid-2015 measured by a JPMorgan index.
“Markets don’t believe Trump’s team will succeed,” said Koon Chow, a strategist at Union Bancaire Privee Ubp SA in London, who recommends buying bonds selectively and being cautious in the short-term on currencies. “While the risks of U.S. protectionism haven’t gone away, for now, markets aren’t rattled.”