Green lights for emerging markets get brighter

Emerging markets have started 2019 well due to a sharp U-turn in monetary policy around the globe and an easing of trade war tension between China and the US. The Fed and ECB’s change in monetary policy was initiated after the ‘blood bath’ in markets in December 2018. This shift has redirected flows from higher yield expectations across developed markets to yield hunting in emerging markets. Stabilisation in the USD in early 2019 versus its sharp strengthening in 2018 has been a big positive driving force for emerging markets despite lots of other persistent risky issues: the China-US trade deal has not been agreed yet, keeping intrigue for emerging markets sentiment; (geo)political turbulence is still in place for Hungary, India, Kazakhstan, Poland, Russia, Turkey and Ukraine. Many economic issues should be solved locally in 2019, for instance in Brazil and China.

In line with markets, we remain confident that the China-US trade deal will be agreed later in Q2 19. Any withdrawal from the current ‘trade talks journey’ by either counterparty would weigh immediately on emerging market sentiment. After US President Donald Trump has dealt with US-China trade, we could see his attention shifting to starting a trade war with the EU. If this happens in May 2019, the biggest losers would be the Central and Eastern European economies. Market expectations are still in favour of Germany’s economic pickup in Q2 19, which is fuelling the Czech, Hungarian and Polish economies, but Trump’s auto tariff idea would spoil the sentiment overnight.

Economic growth in emerging markets is set to slow down less than expected on easing monetary conditions. Given stabilisation in currencies across many emerging markets, accelerated inflation is set to calm down in H2 19, allowing emerging markets’ central banks to follow a change of monetary stance in developed countries. We have seen the first shoots of monetary easing in China and India in Q1 19. We also see tentative signs of a bottom in China (PMI, metals), which has eased concerns about a hard landing in the country. Other Asian economies are likely to follow the pattern very soon, while Russia, South Africa, Turkey and Brazil could join the cuts later in 2019, helping economic expansion in particular looking ahead to 2020.

We now see many yellow lights in the emerging market risks heat map becoming green, while the green lights are becoming even greener. However, there is still a risk that a possible new TRY crisis will put the brakes on the appetite for emerging markets in H1 19.