The US Fed is widely expected to cut rates this month, signalling a significant shift towards global monetary easing. Meanwhile, global growth is slowing and could bring vulnerabilities to EM/frontier markets. Then there’s the looming risk of further escalation of trade war tensions, although a fragile truce may exist for now. And will softer oil demand outweigh supply factors, notwithstanding US-Iranian tensions?
As we enter the second half of 2019, we think these are the four global themes will shape the outlook for developing markets for the rest of the year.
1. Global monetary easing. The Fed is expected to cut rates at the end of this month – if it does, it will be the first cut this decade. Looking at EM bond performance during previous US Fed easing cycles, we can conclude (tentatively), that EM bonds generally perform well if the easing is associated with a slowdown rather than a recession. No surprise.
Lower US bond yields in response to lower short-term rates would benefit EM yields (beta). Whether EM country spreads fall (alpha) will depend on whether EM fundamentals are seen as improving or worsening. This will depend on individual country circumstances. Lower US rates might also be dollar negative (EM FX positive), but other factors could mitigate the positive impact on EM currencies.
2. Slower global growth. Global GDP growth has eased over the past year, from nearly 5% to just over 2.5%. Policy accommodation could mitigate the impact, but we think some frontier markets have limited space to manoeuvre as a result of their higher public debt burdens, while slower growth can exacerbate the vulnerabilities of EM/frontiers, not least in terms of fiscal slippage, unfavourable debt dynamics and political choices. The former (looser monetary policy) may beat the latter (slower growth), but investors will need to be aware of potential tipping points.
3. Re-appearance of the US-China trade war. This is obviously related to – and, in part, a driver of – the second point. A fragile truce may exist for now. But it is unpredictable. And other countries risk getting dragged into a new era of protectionism as the traditional global order breaks down. There might be winners and losers in EM/frontiers from trade displacement but, the longer this continues, the more damaging for the global economy it will be.
4. Oil prices. Softer global demand may outweigh supply factors, even as OPEC+ seeks to increase production quotas. The impact of Middle East tensions (specifically over Iran’s nuclear programme) may also lead to price spikes. Average WTI prices YTD are US$57/b, just below the US$65/b in 2018, so the year has not been a boon for oil exporters thus far.