Transcript
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.
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Speaker: The following podcast was recorded for publication on Thursday 20th July 2023.
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Speaker: Hello, I'm Piers Butler in London and welcome to the Macrobrief.
Speaker: This week we're taking a close look at emerging markets, which enjoyed a broadly positive first half, but as we head into the summer months, risks are still lingering, particularly around growth, inflation and monetary policy.
Speaker: Murat Orgen, Global Head of Emerging Markets Research, has just released his latest outlook, and he joins me in the studio.
Speaker: Murat, welcome to the podcast.
Speaker: Thanks for having me.
Speaker: So here we are, mid-July, the start of what you refer in the report as the summer lassitude.
Speaker: But before we talk about the outlook, I wanted to go back to the start of the year, because here we were in January after two years of negative returns in emerging markets, and you were arguing for...
Speaker: hopefully better positive returns what's happened in the six months sure thanks pierce yeah indeed we were hoping for a better performance after those two unpleasant years let's put it that way 2021 and 2022 and actually at the start of the second quarter we bulled up on the em carry trade which effectively you can define as
Speaker: borrowing in a low yielding funding currency and investing in a higher yielding currency.
Speaker: And generally this has been done by borrowing in US dollar or euro, investing in high yielding emerging market currencies or local currency assets.
Speaker: And the EM carry trade has actually performed pretty well.
Speaker: And it has also helped with the local debt market returns, partly because of a benign US dollar backdrop and partly because of low global macro visibility.
Speaker: where you focus more on sort of short-term strategies.
Speaker: And Latin America in particular has recorded stellar performance as a region across the board, equities and fixed income.
Speaker: Yeah, so far in the first half of the year, carry trade and local debt markets have been good strategies and they've yielded good performance.
Speaker: So just to sort of reconfirm on that one, this was all based on the fact that emerging markets had moved on interest rates early and had reached levels at which we anticipated that we could see some potential easing and that would help the sort of carry trade.
Speaker: And so, as you say, that has worked.
Speaker: But where do we stand now?
Speaker: Sure.
Speaker: It has.
Speaker: I mean, many emerging market countries have been very prescient, and they started their monetary tightening a lot earlier than the developed world.
Speaker: And some have seen pretty substantial downward momentum and inflation.
Speaker: So this sort of high nominal and real years, they've definitely helped.
Speaker: Now, as sort of, you know, quite summer months set in, well, hopefully quite, it still makes sense to stick to the strategy.
Speaker: And there is still momentum behind it.
Speaker: We have this peaking global rate cycle.
Speaker: We still have a relatively benign US dollar backdrop.
Speaker: So we're not making drastic changes to our EM views, and we still stick to this winning strategy so far.
Speaker: But there are risks, so let's take them one by one.
Speaker: Firstly, on the downside, there's always this thing in the markets that a good idea becomes a consensus.
Speaker: Doesn't everybody know about this carrot trade?
Speaker: That is true.
Speaker: I think this is one of the biggest risk peers.
Speaker: You're spot on.
Speaker: It has become too consensus a trade.
Speaker: And we can track it actually.
Speaker: The positioning has increased.
Speaker: So in that sense, yes.
Speaker: I mean, it's not a new strategy.
Speaker: It's just, you know, quite summer months and the momentum behind it could still, you know, move it forward.
Speaker: But yes, it has become consensus.
Speaker: That's one of the key risks for sure.
Speaker: Now, what about base effects, or what we would refer to as the end of easy in terms of inflation having already come down a lot?
Speaker: Sure.
Speaker: Well, base effects were very influential for inflation to come down.
Speaker: Obviously not the only reason, you know, PPI.
Speaker: which is the producer inflation points to more cost side pressures.
Speaker: It has come down substantially, taking the headline actual consumer inflation down.
Speaker: But base effects were really big and we've kind of exhausted the base effects.
Speaker: And what we mean with end of easy, we actually say this inflation from here would be arguably more difficult.
Speaker: And one of the reasons for that is you have this core inflation, which is essentially defined as the underlying inflation.
Speaker: Usually you take out some components that are not under the control of monetary policy like food, energy.
Speaker: You take it out of the headline inflation and what is left is defined as the core inflation or the underlying inflation.
Speaker: Now we're in this peculiar situation where actually headline inflation has come down a lot, the actual consumer inflation, but this underlying core inflation is still elevated.
Speaker: and there is persistence because of the component of services within core.
Speaker: So in this peculiar situation where actually core is higher than headline, the convergence takes longer than the other way around based on our analysis as we detail in this report.
Speaker: Now, there's another risk which I find really interesting, which is actually situated in developed markets.
Speaker: And this is what you refer to as the developed market discrepancy.
Speaker: Can you explain?
Speaker: Of course.
Speaker: Well, look, you know, markets are quite keen to price and rather substantial monetary easing by the developed markets at the width of...
Speaker: you know, weak data or in the past we had tail risks like, you know, hard landing concerns or banking sector woes in the developed markets or, you know, these debt ceiling worries, et cetera, et cetera.
Speaker: I mean, obviously the market prices keep changing, but there's still fairly big rate cuts priced in into the developed market curves for 2024.
Speaker: Whereas HSBC, we're not expecting, you know, quick rate cuts.
Speaker: So that's one discrepancy that the
Speaker: core center bank rates might stay longer for a higher for a longer and protracted period of time.
Speaker: If not, they hike it even further.
Speaker: And this would obviously limit the room for EM center banks to cut rates because otherwise the rate differential would narrow and this may weigh on the currencies and the credit rate.
Speaker: So we talked about downside risks, but there is one upside risk I wanted to explore, and that is China.
Speaker: Obviously,
Speaker: The China reopening boost didn't come through as strongly as people expected, but it's still 5% growth, more or less, which is still strong growth.
Speaker: So are people being too bearish about China?
Speaker: I think the sentiment has swung too much.
Speaker: I agree with you.
Speaker: That also shows up in our EM sentiment surveys, where in the past, in the beginning of theory, investors were looking for China as a major uplifting force for EM, but then they have curtailed that expectation.
Speaker: into the latest surveys.
Speaker: And I think, yes, the sentiment is just too negative.
Speaker: As a matter of fact, around 5% growth is still pretty good.
Speaker: And now there are talks of stimulus and also, you know, some steps of stimulus.
Speaker: And obviously we have a major plenum coming up in autumn.
Speaker: which would like to focus on the economy.
Speaker: I think China, yes, at the moment, maybe there is a subdued recovery and the forecasts are being taken down, but it could be an upside risk as well, given how much sentiment has come down and the potential for economic stimulus.
Speaker: And even if it's around 5% growth, it's actually not that bad.
Speaker: So you referenced investor sentiment.
Speaker: And of course, you do this sentiment survey of emerging market investors covering about a half a trillion of institutional funds invested in emerging markets.
Speaker: And the response from the last survey was quite sanguine.
Speaker: Investors did perceive risks, but hadn't adjusted their positioning that dramatically.
Speaker: Of course, the survey was done
Speaker: at the end of April, beginning of June.
Speaker: Here we are in the middle of July.
Speaker: There has been some funds flow data.
Speaker: So where do you think investor positioning is now?
Speaker: I think investors were still broadly constructive on EM.
Speaker: You know, maybe not necessarily as constructive as they were in March, but in the June survey, which is a forward-looking survey covering sort of the summer months, they were still broadly constructive.
Speaker: And actually, they've become even more constructive specifically for EMFX.
Speaker: Because one of the questions we asked them, do you expect emerging market currencies to appreciate or depreciate and take the net sentiment?
Speaker: And that net was the highest in surveys history over the past three years, which kind of, you know, alludes to the EM carry trade.
Speaker: So, yes, I think you're right.
Speaker: I think if it's aim broken, don't fix it.
Speaker: And there is still relatively sound sentiment for the summer months.
Speaker: And that has also showed up in the EM sentiment survey in the latest edition.
Speaker: So just to come back to the title of your report, so carry now, worry later.
Speaker: Broadly, you're sort of arguing that although you identify some risks on the horizon, you're not advocating any major changes.
Speaker: Are there any specific geographies where you think things are looking better than others?
Speaker: Sure.
Speaker: I think the way we have from here is just to take some insurance into what could be a choppy autumn months in terms of growth inflation combination.
Speaker: There are still uncertainties.
Speaker: And also there has been pretty substantial carry trade and local markets rally already.
Speaker: So we're taking some insurance and we're not done our enthusiasm a bit and focus more on selective carry trade and local market strategies and stories.
Speaker: And, you know, since you ask among some markets, the economies we favor more compared to the others would be Brazil and Mexico.
Speaker: Czech Republic in South Africa and India and Indonesia, but also the GCC region where there is a structural story.
Speaker: I think when it comes to Asia and the low yielders, it's more about would you hedge your FX risk and still invest in local assets, which still makes sense.
Speaker: So yes, we're becoming a little bit more selective, not giving up on the carry strategy.
Speaker: We don't want to lean against the wind.
Speaker: There is still momentum, but it has already come down a lot.
Speaker: We've seen a big rally, and the autumn months could still be a little bit choppy and uncertain.
Speaker: So why don't we take a bit of an insurance and narrow down our scope
Speaker: and focus more on selective stories where either there is a sort of structural transformation and or the risk premium is fairly attractive.
Speaker: So looking through the summer months, what are the sort of key catalysts as we come back into the autumn for emerging markets?
Speaker: What are any big data points or big events that might trigger a change in positioning?
Speaker: I think first and foremost, we will follow the core centre banks and whether the market's pricing of
Speaker: fairly substantial easing next year will materialize or will be telegraphed by core center banks.
Speaker: That would be very important.
Speaker: And then, I mean, as you said, it's China.
Speaker: China outlook.
Speaker: Again, we still think around 5% growth is pretty good.
Speaker: But now there's upside risk with the upcoming plenum.
Speaker: So in an ideal world for emerging markets,
Speaker: if the developed market center banks finish their rate hikes, and if we see some upside risk in China, that would actually further support a bright outlook for emerging markets.
Speaker: But in the meantime, I think the carry trade strategy, as much as is perhaps a bit positioned and a consensus, it still yields a relative attractive real and nominal interest rate differential with the developed world.
Speaker: And the key here is another thing that we need to follow is
Speaker: how fast and abruptly some of the emerging market center banks will cut rates because some are poised to start easing cycle very soon, especially in America.
Speaker: Actually, some of them could start cutting as soon as this month and the remainder of the year.
Speaker: So it's all about the interest rate differential and the growth outlook that we need to follow.
Speaker: And obviously, on the technical side, how much positioning is in this trade.
Speaker: We're getting there, but we can't say it's really very heavily positioned.
Speaker: It's a consensus trade, but it still has some momentum behind it.
Speaker: Well, Murat, I am going to have to stop you now, but thank you very much for joining us today.
Speaker: It's a pleasure.
Speaker: Thanks, Piers.
Speaker: Murat Olgen there on the outlook for emerging markets.
Speaker: By the way, if you're an HSBC client and the discussion whetted your appetite for more, don't forget to register for the HSBC Global Emerging Markets Forum, which is taking place online in September.
Speaker: Just contact your HSBC representative for all the details.
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