The Fed and China a headache for EM

Geopolitical fears have dominated emerging market sentiment nearly all year. However, as geopolitical fears seem to be easing on the back of the – admittedly fragile – ceasefire in eastern Ukraine, other concerns are showing up.

Paradoxically, it is good news for the US economy that might start to worry emerging markets investors. Hence, in recent weeks, US macroeconomic data has continued to surprise positively and this has caused investors to fear that the Federal Reserve could initiate monetary tightening earlier than thought. Furthermore, markets continue to worry about the strength of the Chinese economy and recent Chinese economic data has added to these fears. As a direct consequence of these factors, we have changed our forecasts in a more negative direction for some of the more commodity- and US-sensitive emerging market currencies.

Our allocation this month includes this major change: Mexico moves from overweight to underweight and Hungary from neutral to overweight. We keep Russia in our underweight allocation, as we have for several months now.

Overweight: Hungary (+9.8%)

Hungary moves to overweight. The economy continues its strong recovery and it now has the strongest GDP growth within the CEE. We continue to believe that Hungary’s fairly strong external position is likely to be supportive for the HUF in the medium term as will the increasingly strong recovery in growth.

Neutral: Turkey (+6.7%), South Africa (3.5%), Poland (-3.4%)

Turkey remains in a neutral position this month, as the continued high inflation and large current deficit are likely to weigh on the lira. Overall, we see a gradual depreciation of the lira. We move South Africa from overweight to neutral as the economy is in worse condition than previously thought. Also, the current account keeps widening, which is negative for South Africa.

Underweight: Mexico (-6.4%), Russia (-10.2%)

We move Mexico to underweight. The combination of the Fed moving towards its first rate hike and renewed bad economic numbers out of China represents a bad cocktail for emerging markets and for MXN particular. We keep Russia underweight this month, as we have done for several months. The main risks continue to be geopolitical, as the sanctions war has been escalating despite the fragile truce in eastern Ukraine.