EM: Global and domestic factors should continue to be mildly supportive - Danske Bank

Global and domestic factors should continue to be mildly supportive for Emerging markets near term according to analysts from Danske Bank. 

Key Quotes: 

“As we have seen over the past few years, emerging markets are affected by both global factors, such as the level of interest rates in developed markets and global growth conditions, and domestic policies and political events.”

“China outlook (slightly negative): As the second-biggest economy and the number one global consumer of metals, economic developments in the Chinese economy have a large bearing on the global economy and, notably, those emerging markets supplying raw materials to China. The strength of the Chinese economy has surprised us a bit this year. However, we see several reasons to be cautious in coming months. (1) The financial tightening over the past year is starting to bite in the real estate and construction sectors. (2) Chinese policymakers seem more willing to address problems relating to high debt and weaknesses in the state-owned sector now that the party conference is behind them and the global economy is in relatively good shape (...) (3) Seasonal steel production ahead of the winter is set to come to halt now. As a result, our models point to a decline in Chinese PMIs over coming months, which typically have negative bearing on other emerging markets and metal prices more broadly.”

“The Fed, the USD and US tax reform (neutral): The recent repricing of the Fed’s likelihood of hiking rates in December and renewed expectations of US tax reform has aided the USD. Apart from the December hike, we continue to expect two additional rate hikes next year, while the Fed dots suggest three hikes.”

“Commodity prices (neutral): Oil prices have doubled since the trough in early 2016. The positive momentum has been strong since September and particularly over the past week. We think that the increase over the past two months has been driven by increasing concerns about supply disruption due to geopolitical events. Most important has been the tension in the Middle East, notably concerns about renewed US oil sanctions against Iran following US president Donal Trump’s hardened rhetoric and the increasingly strained relations between Iran and Saudi Arabia (the two countries together account for 15% of global oil production). These tensions are likely to remain and hence provide support to oil prices near term, which would be positive for oil-producing emerging markets such as Russia, Indonesia, Nigeria and the Middle East economies but would spell trouble for large oil-importing countries such as Turkey and South Africa.”

“Domestic emerging market fundamentals (slightly positive): When the taper tantrum hit emerging markets in 2014, many emerging markets, such as India, Brazil, Turkey and South Africa, ran large current account deficits. These have (maybe apart from Turkey) been reduced significantly, partly as emerging market currencies depreciated following capital outflows. Hence, these currencies are now more in line with their long-term value than in 2014. Furthermore, the central banks and ministries of finance in many emerging markets are following quite orthodox economic policies. Inflation in emerging markets has fallen to the lowest level on record. Compared with developed economies, the public debt burden is significantly lighter. While some emerging markets still have sizeable USD debt, making them vulnerable to a stronger USD, the size is relatively limited compared with GDP in these countries. So, overall, emerging market fundamentals provide a stronger foundation for these countries.”