Emerging markets at a crossroads

Emerging markets (EM) have enjoyed favourable external and internal environments this year. While the reflation story has faded across the largest markets, brisk global economic growth and conservative economic policies combined with attractive carry have kept investors inside the EM universe, pushing valuations up.

Conservatism in monetary and fiscal policies has been fuelling disinflation across many EM economies: Brazil, India, Russia and South Africa, for instance. Indeed, while inflation in the euro area and the US has accelerated from its low levels in 2016, EM inflation has fallen to an all-time low, pushing the inflation differential with advanced economies to its narrowest in 17 years. Given the current trend in core inflation and moderately tight monetary policies and subdued commodity prices, we expect the disinflation trend to continue and inflation risks in the EM universe to stay low. Stabilising EM currencies, high carry and monetary tightening in developed economies have accelerated the shift to local currency debt, improving EM's external position. Recovering macro is still outweighing geopolitical woes, as, for example, the share of non-residents in Russia's local debt (OFZ) climbed to an all-time high in May 2017, surging over 30%. However, growing EM have come to a crossroads, where despite good sentiment, fed by optimistic PMIs, several external risks arise.

What risks are facing EMs at the moment? The Fed's reduction of the balance sheet, higher rates and the stronger USD would clearly cool down EM. While for months we have been expecting the Fed's next hike to come in December 2017, markets have now started to price it more aggressively. Asian economies could be hit by the rising crude oil price and the worsening situation in North Korea. There is also big uncertainty over China's growth prospects, once the Communist Party Congress is over this autumn.

We believe EM are more immune to risks than before the crisis in 2008-09. Yet, it has become more difficult to see reasons for a similar growth acceleration in 2018 as in 2017. Looking to Q4 17, we still see some potential in carry trades among EM countries, as we did for Q3 17. Rate differentials remain attractive, especially in Brazil, Russia and Turkey. However, the effect will continue to fade on converging monetary policies in the EM and the DM universes.

Download The Full Emerging Markets Weekly

Share: Analysis feed

This publication has been prepared by Danske Bank for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Bank's research analysts are not permitted to invest in securities under coverage in their research sector.
This publication is not intended for private customers in the UK or any person in the US. Danske Bank A/S is regulated by the FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange.
Copyright () Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.