Navigating EM turbulence

Key points

  • Turkey’s woes have hit emerging markets. We expect further volatility, yet see long-term opportunities in markets with strong fundamentals.
  • EM equities lagged broader global markets, dragged in part by weak Chinese tech stocks. Copper prices hit a one-year low.
  • Minutes from the Federal Open Market Committee could signal an earlier end to the Federal Reserve’s balance-sheet drawdown than expected.

Worsening relations with the U.S. have spurred a sharp selloff in Turkish assets and exposed economic weaknesses such as large external debt loads and rampant inflation. We see many of these problems as unique to Turkey, yet other EMs have felt the heat. We remain wary of markets with high debt and deteriorating growth, and see long-term opportunities in regions with sound fundamentals, such as EM Asia.

Rising macro uncertainty, higher interest rates and a strengthening U.S. dollar have led to a modest tightening of global financial conditions. This has laid bare vulnerabilities that had, until recently, been masked by plentiful global liquidity. Countries reliant on external borrowing to fund growth and large current account deficits — such as Turkey and Argentina — have suffered the most, as the chart above shows. Currencies of both have lost more than 40% against the U.S. dollar this year to date. Yet both Turkey and Argentina are relative outliers within the EM world. Many other EM countries, especially in Asia, appear healthier with improving current account balances. And structural reforms in countries such as China and India are likely to put economies on the path to more sustainable, long-term growth, in our view. See our emerging market marker to compare EMs across key metrics.

Look east

Investors have latched onto Turkey’ s weak fundamentals — bubbling under the surface for years — and rushed for the exits after the country‘s relations with the U.S. took a sharp turn for the worse. Turkey’s woes have brought into sharp focus the dangers of a reliance on external debt-fueled growth. We believe the weakness could persist as markets are skeptical that Turkey will take the necessary steps to address these underlying issues.

The dent to broad EM sentiment is undeniable. Currencies, especially of countries dependent on borrowing in dollars, have sold off. Outflows from equity and debt funds have resumed, according to EPFR. Poor equities and debt performance in 2018 after two strong years has dampened investor appetite. Some safe-haven assets now offer positive real returns and investors see brighter prospects in markets such as the U.S. If the latest proposed U.S. sanctions come down hard on Russia, this could further dent sentiment on EMs. – Richard Turnill, BlackRock, August 20,2018

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