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The Macro Brief – Testing emerging market resilience
127 Plays1 hour ago
Murat Ulgen and Ali Cakiroglu look at whether geopolitical developments have dampened investor sentiment towards emerging market assets.
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Transcript
Introduction to HSBC Global Viewpoint
00:00:02
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto to today's show.
Geopolitical Developments in Emerging Markets
00:00:33
Speaker
This is the macro brief from HSBC Global Investment Research, the podcast that looks at the issues driving financial markets around the world. I'm your host, Piers Butler, and on today's episode, we're looking at whether geopolitical developments have dampened investor sentiment towards emerging market assets.
00:00:49
Speaker
Drawing on our proprietary survey of EM investors, we look at changes in risk appetite, portfolio positioning, as well as how the picture is looking in the longer term.
00:01:00
Speaker
In the studio with me is Murad Olgan, Global Head of Macro Strategy, and Ali Chakiroglu, Senior Emerging Market Strategist. Murad and Ali, great to have you back on the podcast. Good to be here.
00:01:11
Speaker
Thanks, Piers. So, Marek, let's
Impact of Rising Oil Prices on Inflation
00:01:13
Speaker
start with you. One of the big concerns from a macro perspective is the inflationary impact of the higher oil price. And it's fair to say that we're already seeing rates markets starting to discount this. Is the specter of stackflation coming back to haunt us?
00:01:26
Speaker
Thanks, Piers. And I mean, as you said, obviously, markets are fully focused on geopolitics, the Middle East conflict, and the risks surrounding it. um So I want to take a bit of a step back. What we discussed in the global macro strategies last week was the the market resilience so far is facing a big test. And, you know, you know the buzzword at the moment is stagflation, as you said.
Energy Shocks and Stagflation Risks
00:01:48
Speaker
but My preference is not to use that word very loosely, but I guess the risk here is with this major energy shock, oil and gas, and perhaps some second and third impacts, are we going to see downside risk to global economic activity and at the same time upside risk to global inflation? Because previously this favorable growth inflation nexus was underpinning risk and the behavior, the pattern in the market was buying the dips.
00:02:14
Speaker
Pretty much since Liberation Day last year, for almost a year, any weaknesses were seen as an opportunity to dip back into risk assets, and this was underpinned by a favorable growth and inflation mix. And now, clear there's a huge test. And the way I read this, and to your point, um markets have priced some sort of an inflation risk so far with the current level of oil price, which is still very volatile. We have seen rate cuts being priced out, and in certain markets there even rate hikes being priced in.
Energy Price Impacts Compared to 2022 Conflict
00:02:44
Speaker
So we actually have seen the rates market, especially the front end,
00:02:49
Speaker
reflecting the move in oil prices and gas prices the energy shock there has been some bear flattening as well so the yield goers have moved up with a bear flattening bias ah now the big question is ah whether there is going to be some growth pricing as well because so far we've seen equity and credit markets behaving relatively better compared to the frontal rates market so there is a bit of a divergence and let's see where we go from here So you mentioned energy shock and there are parallels with the energy shock in 2022, but also major differences. Can you explain what these are and how that impacts your outlook?
00:03:22
Speaker
Absolutely. I mean, 2022, obviously Russia-Ukraine war has caused a major spike in energy costs, oil and gas, but also in agricultural commodities. And we are already coming back and reeling back from the supply disruption caused by the COVID pandemic previously.
Emerging Markets' Initial Conditions Amid Tensions
00:03:39
Speaker
Now, those high energy prices, they acted as a tax on global demand while at the same time pushing inflation higher. So kind of raising the risk of stagflationary backdrop, you know, that is probably the parallel. But but then there are big differences as well. As a starter, maybe on a more positive note, the current level or the initial conditions of inflation, monetary policy, financial conditions and real rates are much better compared to the episode because it was twin shock, supply disruption by COVID and the Russia-Ukraine war. You actually already have some real risk premium in certain markets, particularly in EM, which I'm sure Ali will mention a second. so The initial conditions are favorable, but I guess on the negative side, this time you have positioning in risk assets, particularly EM, which has seen significant inflows. So there are some parallels, there are some differences. I guess investors are sort of looking at the stagflation element, but it's not the exact same backdrop. I guess the initial conditions are favorable, but there is positioning when we have started this, the impact of the conflict.
Bullish Investor Sentiment Despite Tensions
00:04:45
Speaker
So talking about positioning, Ali, let's bring you in here. We have just had the latest results of our EM sentiment survey. We feature the EM sentiment survey regularly on the podcast, but remind our listeners who we are surveying and crucially for this latest one, what period did it cover?
00:05:02
Speaker
Well, we're basically surveying institutional investors covering emerging markets from all walks of life. So it's EM, those who are investing into EM equities, EM fixed income, both local currency and hard currency debt, as well as EM FX. And the last survey was conducted ah between 28th of January up until 13th of ah March. So the timing actually partially overlaps with the recent escalation of geopolitical tensions given the ah Middle East conflict.
00:05:35
Speaker
And at the same time, in this survey, it was 102 investors from 102 institutions representing 444 billion of EM's assets under management.
00:05:47
Speaker
So I guess a tricky one to interpret, given the survey period, as you said, straddles the start of the conflict in the Middle East. Can you start by summarizing the key overall readings? Has the situation in the Middle East had an impact?
Cautious Investor Behavior Amid Bullish Sentiment
00:06:00
Speaker
Well, It was tricky and interesting survey because, as you said, the survey coincided with the developments in the Middle East. But one thing, the first thing I would like to say is the fact that investors are still quite constructive on the emerging markets. As a matter of fact, the bullish views has picked up compared to the December survey. Which was already very bullish. It was the second highest, all-time second highest bullish level. But this time around, we have surpassed that level. So 68% of survey respondents were bullish, and the bearish views were absent for the second consecutive survey. And as a result, the net sentiment survey was 68%, the highest level in that survey. And in terms of you know the positioning, actually, even though the headline level is
00:06:50
Speaker
very strong, I can say that the action, the behavior of investors are a bit more cautious. Give us a bit more on that, because that was interesting that despite this kind of headline bullishness, there are some signs of caution coming through.
00:07:04
Speaker
Indeed. And actually, this is the real nuance of that report, because if you look at the overweight positions, we have seen these being trimmed across almost all asset classes, particularly for the fixed income, especially in local currency debt. The net overweight positioning was positive, it turned negative, and we have seen significant decline in the overweight positioning for hard currency debt as well. So the positioning has come down, but it wasn't only the positioning. If you look at the cash holdings, in the previous December survey, cash holdings were record low at 4 percent of assets under management. Now they have picked up to 4.7 percent. so
00:07:43
Speaker
As a matter of fact, investors are have built some dry powder. And I mean, in my view, how I read this, how I interpret this, yes, the recent conflict led to as sort of some adjustment in the positioning, but investors still see, still feel that the longer term yen store is intact. And if anything, in the survey, we are also asking investors how they are willing to use their cash holdings and 34% of survey respondents actually said that they are willing to reduce.
00:08:14
Speaker
And in line with that, we have also seen that the risk appetite score remaining strong and picking up from 6.5 to 6.9. Well, time will tell how that
US Dollar as Safe Haven and Emerging Market Impact
00:08:24
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sentiment evolves. But Murat, not surprisingly, geopolitics is now the top downside risk in the survey. But that's followed by a stronger dollar. Can you explain why that is a concern for EM investors? Sure. I think this episode has shown, Piers, that US dollar still remains one of the main safe haven currencies.
00:08:44
Speaker
um I mean, investors have been contemplating about Japanese yen, but Japan is a major energy importer. Swiss franc, but there are always intervention worries. Gold, we have actually seen gold prices coming down. ah Maybe, you know, ah some urge to raise cash. So US dollar has proven to be the main safe haven currency. So the FX team has called this Buy America. I frame it more like US's outperformance, both in terms of currency and perhaps equity markets as well. um I guess going back to what Ali said, and we've seen a big reduction over the positioning, especially local debt, US dollar's weakness for the past year was one of the major contributing factors of strong local debt performance and equity performance. Not the only factor,
00:09:27
Speaker
But it was an important factor, and an important component. And obviously now US dollar making a bit of a comeback ah makes people question the overall return on local debt instruments and local equity instruments at Rocio.
00:09:41
Speaker
Ali, in last week's podcast, we did a feature on LATAM, and the survey seems to echo our stance that this region is at least from a sentiment perspective benefiting from the disruption elsewhere in the world.
Positive Outlook for Latin America
00:09:51
Speaker
Is that underpinned by fundamentals?
00:09:53
Speaker
I think so. But as you rightly said, LATAM is now the only region with positive net sentiment scores across all asset classes, both fixed income, local currency, and hard currency, that equities and effects. And I guess that partly reflects...
00:10:09
Speaker
to one fact, you know, in an environment where geopolitics has become more important, regions that are less directly exposed to the current shock can look more attractive on a relative basis. And that's one of the drivers why investors might be preferring LATAM as a region. But fundamentals also do play a role. Because when you look at LATAM, it still offers attractive carry. Both nominal and real yields are high. And at the same time, the policy direction is quite prudent, which allows the region to perform in an environment where geopolitics becomes a a problem.
00:10:47
Speaker
right Can we maybe finish with you on on sort of overall thoughts, how you perceive the situation involving the more it continues?
Underpricing of Growth Risks in Markets
00:10:55
Speaker
Yes, um so as mentioned, we've seen a decent amount of pricing of inflation risk in local rates across EM and DM, where rate cuts have been priced out, and some markets are even pricing rate hikes. What has been probably less priced in is any potential fallout on growth and activity, you know, whether this situation, if it lasts longer, an energy shock will weigh on activity and whether markets will price it in.
00:11:20
Speaker
Generally speaking, in this environment, we're still relatively cautious on duration in credit and rates. ah I think some parts of the world may be seen in relatively better light. Maybe U.S. markets, Chinese markets, mainland China markets, and broad revenue stability is actually a good thing as well. And finally, circling back to what Ali said, Latin America is also seen ah in a relatively relatively better spot.
00:11:43
Speaker
Ali, any final thoughts? Well, one point that I can add as a follow-up to Murad, actually in the survey, we are also asking investors about their thinking on the growth and inflation outlook. And to Murad's point, we have seen investors are less ah sure about the disinflation.
00:12:01
Speaker
We have seen a big revision on their expectations on the disinflation, but they are still see economic activity doing better. So yes, to some extent, you can argue inflation risks are being priced in, but growth risks are still missing. So if we were to start pricing for a downside, a a sharper slowdown in economic activity, then I think it would also have some implications to the emerging market asset classes. Investors still see EM equities doing better compared to the other asset classes, with both on a relative and absolute basis. So it might lead to some repricing or re-questioning about the strength of EM equities as well.
00:12:44
Speaker
Well, we'll have to see in the next survey. But for now, thank you very much for joining us. Thanks, Piers. Thanks for having us.
Stay Updated with HSBC Resources
00:12:57
Speaker
Before we go, a reminder that you can keep up to date on all our latest reports, videos, and podcasts by downloading our app from Apple's App Store or Google Play, including our Asia-focused sister podcast, Under the Banyan Tree.
00:13:09
Speaker
And if you've got any questions or comments, then you can get in touch with us at askresearch at hspc.com. This week's macrobrief was hosted by me, Piers Butler, and produced by Tom Barton.
00:13:21
Speaker
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00:13:53
Speaker
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