COVID | Economics & Growth | Emerging Markets | FX
Emerging markets had a bumper November. EM currencies gained around 3% on average, with several big EMs strengthening by much more. Equities had one of their best months in over three years, and appetite for EM dollar debt was strong. But can these gains last? And will they be driven by country-specific factors or simply a global rebound and weak dollar story?
A string of upbeat 2021 outlook publications coupled with large equity inflows through November have buoyed markets. Concerns that new restrictions to combat still-rising virus counts will weigh on near-term activity have largely been overshadowed. Within EM, most of the increased restrictions have been concentrated in CE3, with most of Asia and Latam continuing to ease restrictions. Apple mobility data largely reflect that trend, with European mobility dropping sharply and Asia (exc. China) and Latam climbing towards pre-COVID levels (Chart 1).
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Summary
- EM sentiment remains bullish following strong November performance and vaccine rollout optimism.
- That EMs have more goods-driven economies (versus service-oriented DM economies) bodes well for continued recovery.
- We caution that rising expectation could conversely mean EM starts to disappoint.
Expectations for EM Are Rising
Emerging markets had a bumper November. EM currencies gained around 3% on average, with several big EMs strengthening by much more. Equities had one of their best months in over three years, and appetite for EM dollar debt was strong. But can these gains last? And will they be driven by country-specific factors or simply a global rebound and weak dollar story?
A string of upbeat 2021 outlook publications coupled with large equity inflows through November have buoyed markets. Concerns that new restrictions to combat still-rising virus counts will weigh on near-term activity have largely been overshadowed. Within EM, most of the increased restrictions have been concentrated in CE3, with most of Asia and Latam continuing to ease restrictions. Apple mobility data largely reflect that trend, with European mobility dropping sharply and Asia (exc. China) and Latam climbing towards pre-COVID levels (Chart 1).
On the data front, EMs increasingly beat expectations last month (Chart 2). Third quarter GDP readings were higher than consensus in many countries, some of the inflation pockets have begun to subside (Mexico and Poland), and, in general, EMs have benefitted from having smaller service sectors than their DM counterparts. Globally, the goods sector is recovering much faster than the more contact-intensive service sector. Global trade has recovered back to pre-COVID levels based on CBP data, IP has gained a lot of ground, while indicators for services such as restaurant bookings and air travel both remain depressed.
EM exports have continued to beat expectations but less so than in recent months. We attribute this to the earlier very strong readings in China (and other Asia tech exporters) leading to forecasts being upwardly revised. It is not, therefore, a reflection of a deteriorating outlook.
And with recent vaccine news leading to broad upwardly revised expectations for 2021, there is increased risk that EM could disappoint. Ongoing structural factors also leave significant constraints, particularly in Latam and Turkey. Several EM currencies have valuations at extreme lows, according to our estimates, but that alone does not guarantee mean reversion anytime soon.
Nevertheless, it seems unlikely that all positive EM news is already priced in. In Asia, we expect the recovery to broaden and accelerate following the export-heavy Q3 GDP readings. This should support earnings and remove the need for further fiscal support. With a weak US dollar, low yields in the US and Biden expected to formulate a more predictable trade policy, EM should benefit across the board. It is notable that Asian currencies were not the top EM performers in November, albeit partly a function of central bank intervention to offset bumper foreign inflows (Chart 3). Asia FX is more of a steady grind stronger with a YTD chart showing 5 of the top 10 in Asia.
In some EM countries significant risk linger. India is the outlier in Asia with activity taking longer to normalize given the very severe lockdown and its greater dependence on services and agriculture. Brazil remains hostage to fiscal reform, while Mexico’s fiscal austerity and bleak investment environment could hinder the recovery. Turkey is moving in the right direction, but it is too early to say whether the recent turnaround will last.
We have more confidence on lasting gains in Asia where country specifics are less likely to derail any rally. BRL, TRY and RUB undoubtedly have scope for strong gains in a risk-on environment. But a mix of geopolitics and heightened country-specific risks argue for locking in short-term gains.
Caroline Grady is Head of Emerging Markets Research at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)