MUFG: Mid-year emerging markets outlook

MUFG: Mid-year emerging markets outlook

Vooruitzichten
Outlook vooruitzicht (04)

2022 has witnessed a lot and we are only halfway. It’s seen one of the worst financial market performances on record, an intense conflict in Europe, the re-emergence of the COVID crisis in China and the first 75bp hike by the Federal Reserve since 1994.

From an EM perspective, the outlook is in a state of flux. EMs were already pricing in a long streak of stagflationary shocks and these have grown louder as months have gone by. Despite starting the year with well-above-consensus forecasts, we have continued to revise our inflation estimates higher and growth projections lower on a combination of commodity shocks, supply disruptions and a tepid post-COVID demand recovery.

Our EM 2022 outlook theme we catalogued in January was centred on “stagflation trepidation” gaining traction this year across the EM complex. Persistent inflation, apprehensions about recession and reverberations of the war in Ukraine reinforce this narrative.

FX views

It has been another mixed week for EM FX performance as the USD continues to consolidate at higher levels following strong gains in Q2 2022. The recent period of consolidation for the USD has resulted in EM FX volatility dropping back from the highs in the middle of this month. The USD has lost some upward momentum in recent weeks as US yields have corrected sharply lower.

The 10-year UST yield has dropped back towards 3.00% after hitting a recent peak close to 3.50%.  The pullback in US yields has helped to provide more support for EM carry currencies such as the MXN and ZAR. Meanwhile, the TRY was boosted by measures that encourage a reduction in foreign currency exposure, whilst LatAm is proving more sensitive to building fears over global slowdown/correction lower or commodity prices.

Trading views

The market seems to be oscillating between buying EM on peaking US yields, to selling EM as it looks into the reasons behind the move lower in US rates. It is the classic barbell of the USD smile with EM normally better placed somewhere in the middle. Certainly, it is much easier to argue that lower US yields are due to the market reassessing growth prospects than being representative of a shift in dovishness from the Fed. While we have sympathy for the potential of a recession, we nevertheless are getting more bullish EMFX overall.

Week in review

Russia formally defaulted on its sovereign debt for the first time since 1918 though given that Russian Eurobonds have traded at distressed levels since early March, the Central Bank of Russia’s (CBR) foreign reserves remain frozen and the largest systemic banks remain severed from the global financial system, we view the default as most symbolic with negligible reverberations across broader EMs.

Elsewhere, the Saudi Central Bank (SAMA) injected SAR50bn (USD13.3bn) in time deposits with commercial banks in a bid to ease a liquidity crunch. The Czech National Bank (CNB) raised rates by 125bp to 7.00% with a laser focus on restoring price stability, whilst both the Central Bank of Egypt (CBE) and the Central Bank of Turkey (CBRT), kept rates on hold at 11.25% and 14.00%, respectively.

Week ahead and calendar

In the coming week, we have Hungary’s rate decision (MUFG: +50bp to 6.40%) and PMI data for June which will signal the scale of the impact on corporates from the ongoing war in Ukraine, supply chain disruptions and elevated global commodity prices.

Forecasts at a glance

We continue to expect the easing of pandemic effects to support recoveries, although the going will get tougher in EMs – key risks stem from a continued tightening in global financial conditions and a lower gear in China.

Core indicators

Mounting global recession risk, anxiety over geopolitical events, tighter monetary conditions, realised inflation and apprehensions that greater risks are building up is weighing on EM securities which suffered the third consecutive monthly outflows in May (USD4.9bn) – we expect this trend to continue given the ongoing deterioration in the global liquidity backdrop.