Tim Ash: The big picture in EM

Emerging Market assets have rallied back well, recovering much of the losses from the immediate shock from the Covid 19 lockdown. The EMBI+ which widened out by near 300bps has taken back nearly half of this widening, and we have seen similar recoveries in EM local rates and EMFX.

The recovery seems to be a reflection of a range of factors:

* Evidence finally of an overwhelming policy response, with global central banks cutting rates, some widening the scope of QE, governments announcing big fiscal stimulus packages, and the IMF itself rolling out various new programmes to support stressed country stories, RFIs et al. A huge amount of stimulus and liquidity has been pumped into the global economy, and some of that has fed thru to risk assets. There is some recognition here that while the impact of Covid19 is huge, the world is not ending, well not yet – albeit let’s wait for the next Trump tweet before we make a determination there.

* And while we are on the subject of QE, it’s been quite interesting this time around how many EMs have been able to launch their own versions of QE/liquidity management of government bond curves, which have helped anchor government borrowing costs, and so far limited the crisis from immediately being felt in a widespread sovereign debt crisis – at least not yet. We have seen QE style policies rolled in Poland, Hungary, Indonesia, Russia, South Africa, et al. I think in part this reflects positive experience of QE in DM, but also the accumulation off a credibility surplus by many EM central banks over the period since the GFC sufficient that investors do not see this as open ended QE, but short term anti-crisis actions, and hence it has not yet unanchored exchange rates. But this is the first global crisis where QE has been an important part of the policy tool kit in EM.

* Lockdowns are ending or being moderated and so there is now hope that the worst of the health crisis might be over and that the economic hit might be moderated somewhat, and the data flow might become more upbeat, albeit low base driven.

* Oil prices have recovered somewhat, as a reflection of OPEC+ supply cuts finally feeding through, some modest recovery in global economic activity, and less gung ho messaging from key global oil players like Saudi Arabia and Russia.

* Pushback around the G20 IDA debt relief initiative, at least in terms of bailing in private creditors. There is greater understanding that for the poorest countries, extending carte blanche a PSI solution might not be beneficial after all if it leads to rating downgrades and defaults. Afterall – this might just crush market access and raise longer term borrowing costs. The default – no pun intended – settings are now for no default, and for a case by case approach rather than a one size fits all approach. And everything seems to be being done on a voluntary basis. It is possible that we see official debt relief extended, including the Chinese, but no PSI, and therein official creditors are in effect helping developing countries meet their private sector obligations. Sure taxpayers in donor countries are helping private creditors get paid, but the benefit is that market access will be kept open, and borrowing costs kept lower. Already the plus is that a host of EM sovereigns have already managed to re-tap markets, which might not have been the case if there had been a big fight over PSI. PSI could still happen in the future, as the true cost of the debt overhang resulting from Covid19 becomes clear, but the sense from the IFIs and bilateral creditors is that this is a debate to be had in the future, as now the focus has to be on firefighting the crisis/disease.

All the above is pretty encouraging, albeit we are left with nagging questions as to what will be the longer term impacts of Covid19 and how that will impact on markets, including emerging markets. Sketching out a few of these below:

First, I guess the first and most obvious conclusion is that global growth and trade will be weaker/more subdued going forward – looking beyond the initial low base bounce back. While QE has helped keep borrowing costs in many EM’s somewhat anchored, debt stocks will inevitably be much higher – likely twenty percentage points higher across EM, and this debt will have to be paid for, and likely through higher taxes, which will act as a drag on long term growth.

Second, US – China, and perhaps even China – Western relations look set to be worse as a result of Covid-19 and we can already see that in heightened geopolitical tensions over Hong Kong, likely Taiwan, and perhaps also set to extend to the South China Sea. With the rise of populism globally, and prospects for a bitterly fought US election looming, it’s hard to see these tensions being put back in the box. Already the trend towards trade autarky, and deglobalisation look set, and now hard to reverse. And if we mull over the fact that the big EM trade over the past three decades was essentially built around globalisation and ever increasing trade volumes, building in the EM-DM growth differential, then EM is set for some big headwinds.

The consensus seems to be that Covid19 has refocused attention on the vulnerability of global supply chains and an over dependency therein China. It seems this will accelerate the home sourcing trend that Trump had already set in motion with his initiation of trade wars. There could well be some EM winners herein as MNCs look to diversify away from China, and the winners are likely to be the larger EMs with big manufacturing traditions, perhaps therein Turkey, Mexico, and Emerging Europe.

Third, lower global growth and higher debt burdens, with existing pressures from climate change putting pressure on food supply, are likely to pressurise social settings and undermine political stability in many Emerging Markets. We were already beginning to see that in many Emerging Markets, just before Covid19, with social unrest in Ecuador, Chile, Iraq, Hong Kong, Lebanon, and even South Africa, amongst many others. This looks set to get worse, and particular pressure points could well be the Middle East, where inflexible political settings, combine with deep underlying structural vulnerabilities, and are made worse by much lower oil prices.

Fourth, the above three points arguably suggests Covid19 will just entrench, and accentuate existing pressure points and narratives. But there is also a more constructive outcome, where events around Covid19 prove to be a turning point against the rise of populism, and the deglobalisation trend.

In this latter respect I would just highlight that it seems as though regimes which have been less effective at dealing with Covid19 are the more authoritarian – Belarus under Lukashenko, Brazil under Bolsonaro, Putin’s Russia, even the US under Trump. The Covid 19 crisis could just expose the limitations of those regimes, and populations might just recognise the limitations of populism. It is notable that more liberal regimes seem to have had a better crisis – Germany, New Zealand, South Africa, and Argentina to name a few. It’s notable I think that Merkel’s capable and technocratic leadership in handling of the crisis has reinvigorated her political capital in Germany and she seems to be deploying that now with the EU Recovery Instrument, with the Rubicon crossed on central EU borrowing, and indeed the result seems to be a move back towards greater Federalism in the EU, deepening and again perhaps even enlarging the EU.

The fiasco in terms of the international response to Covid19 might actually see a recognition again of the benefits of a multilateral approach to solving the world’s problems, and therein a push back against Trump’s nation first agenda.

Fifth, I am a little surprised there is not much more focus yet on the lynchpin nature of looming US elections.

Perhaps above I suggest that the impact of Covid19 could either entrench existing trends towards de-globalisation, nationalism/populism, or serve as a wakeup call, moving the world back the other way, to some of governance mean reversion. But in all this it is clear that US elections will be central.

It’s tempting, I know, to argue that Trump has let the genie out of the lamp, and that populist/nationalist forces were always there but kept constrained by existing rigidities in political systems in many democracies – the two party system in the US, constituency first past the post system in the UK, PR in Europe. All these tended to count against mean aversion. But Brexit, the rise of Five Star in Italy, the FN in France, the AfD in Germany, Brexit, et al showed that a substantial share of populations in liberal market democracies actually always supported more illiberal agendas, but simply lacked a political outlet in existing systems. Brexit and Trump May have broken these moulds. But I still think that if Trump loses in November, a future Biden presidency is not going to be that out of kilter with that of Obama or the Bushes before. Mean reversion will quickly re-establish itself. The establishment aversion to Trump has been so keenly felt that the old elites will quickly rally back around to present Trump II, the movie. That said, if Trump wins in November, I think the changes a second term Trump could introduce could be terminal for that same political establishment and key US institutions. Frightening indeed! And this just all underscores the critical nature of the looming elections.

And given the critical nature of the US elections I am surprised that the markets are not already trading on outcomes therein. In particular, who would be the winners/losers from a Biden win, or otherwise.

On the winning chit from a Biden win, would have to be global trade and growth, it should be good for EM, as it would make something of a return to the global multilateral order, it should be good for Europe, China, and Iran. The dollar likely suffers and losers likely would be authoritarian regimes which more likely would be held to account by a Democratic Party led administration, so think there the likes of Russia, Turkey, Egypt, even Saudi Arabia.

On Trump, and assuming a likely Biden win at this stage, I do worry given the perceived legal jeopardy Trump and family might be in if he loses the election, what lengths he is willing to go to win. The danger therein is of a massive escalation with China or Iran in the run up to the vote – we are seeing some of that playing out now with China. And the question also is, even if he loses in November, how Trump manages the transition between November and February. What lengths would he go to secure a peaceful retirement from office for him and his entourage? Suffice to say US politics could well prove to be the biggest risk and most destabilising factor to global markets over the next 6-9 months. Indeed, that already seems to be panning out.

** Please note that any views expressed herein are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions. The views expressed do not reflect the opinions of all portfolio managers at BlueBay, or the views of the firm as a whole. In addition, these conclusions are speculative in nature, may not come to pass and are not intended to predict the future of any specific investment. No representation or warranty can be given with respect to the accuracy or completeness of the information. Charts and graphs provided herein are for illustrative purposes only.

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Published By: Atilla Yeşilada

GlobalSource Partners’ Turkey Country Analyst Atilla Yesilada is the country’s leading political analyst and commentator. He is known throughout the finance and political science world for his thorough and outspoken coverage of Turkey’s political and financial developments. In addition to his extensive writing schedule, he is often called upon to provide his political expertise on major radio and television channels. Based in Istanbul, Atilla is co-founder of the information platform Istanbul Analytics and is one of GlobalSource’s local partners in Turkey. In addition to his consulting work and speaking engagements throughout the US, Europe and the Middle East, he writes regular columns for Turkey’s leading financial websites VATAN and www.paraanaliz.com and has contributed to the financial daily Referans and the liberal daily Radikal.