EM remains vulnerable to periodic (and seemingly more frequent) bouts of risk-off sentiment, and next year should be no different. We think markets are overemphasizing US recession risks and expect the yield curve to steepen in the coming weeks. If so, this would most likely be negative for EM. In a sense, it’s a lose-lose situation for EM no matter what happens to US rates.
Meanwhile, trade tensions are likely to continue in 2019. Despite the 90-day truce between the US and China, many thorny issues remain unresolved. Looking elsewhere, the so-called USMCA (NAFTA 2.0) may be reopened by the incoming US Congress.
Outside of the US, global growth is at risk. While we remain constructive on the US, it appears that China and the eurozone, the second and third largest economies in the world, are clearly slowing more than anticipated. Japan also posted a weak Q3, though data was distorted by natural disasters. While 2018 began with notions of a synchronized global upturn and robust global trade, it seems the exact opposite is true for the start of 2019.
The five worst EM currencies in 2018 have been ARS, TRY, BRL, ZAR, and RUB. A negative global backdrop, coupled with idiosyncratic risks, has fed this underperformance, and we think this is likely to continue in 2019.
Q4 data suggest that growth is slowing much more than previously anticipated, which means more stimulus measures are likely in 2019. Weak Chinese growth has ripple effects throughout EM, whether directly (via trade links and the supply chain) or indirectly (via lower demand for energy and industrial raw materials).
President Xi is walking a fine line at home. US-China trade tensions are likely to remain unresolved. As of this writing, there has been a slight thaw. While Xi cannot appear weak in dealing with the US, neither can he sacrifice growth. We do not think China’s policymakers will weaponize the yuan, and so we think it will trade largely in line with wider EM in 2019. Further stimulus is likely to be seen in 2019, both fiscal and monetary.
The crisis has eased, but tight monetary policy is still needed to fight inflation and that will lead to a second recession under Macri’s watch. The peso has stabilized with the help of an IMF program, but it remains vulnerable to swings in market sentiment.
To Macri’s credit, he has taken tough measures that will undoubtedly harm him at the polls. He will be challenged by the Kirchner/Fernandez wing of the Peronist party, whose populist policies may appeal to a disillusioned electorate. If Macri does not win a second term, then there is a significant risk that his reforms will be reversed by the incoming administration.
After some initial exuberance, markets have come to realize that the job ahead will be very difficult, if not impossible. Some minor reforms may be pushed through, but we suspect the more difficult ones will languish in Congress.
Inflation remains low, tilting the central bank to a more dovish stance in recent months. This has helped push out tightening expectations into H2 2019. However, incoming head of the central bank Roberto Campos Neto will have an opportunity to choose his own path. The dovish outlook along with low commodity prices is likely to keep the real trading with a softer bias next year.
Markets have come to realize that AMLO is unlikely to be the savior that many expected. Even before he was inaugurated, AMLO sent some bad signals to the market (the Mexico City airport fiasco, among others) that he has tried unsuccessfully to walk back.
Weakness in the peso and resulting inflation has forced Banco de Mexico to hike rates even as the economy remains sluggish. Low oil prices are another headwind ahead, as recently announced OPEC+ cuts have yet to have a significant impact on the oil market. Lastly, there are downside risks to the economy if there are any significant revisions to the USMCA that could impact trade flows.
The ouster of former President Jacob Zuma has helped the ANC get better traction with the populace, as recent polls are showing around 56% support, up from 52% in September. The opposition has been unable to build on its recent electoral successes, as the two major parties have often been at odds with each other.
Growth remains sluggish and unemployment remains near record highs. Yet the South African Reserve Bank has been forced by the weak rand and rising inflation to start a tightening cycle. With commodity prices languishing, the headwinds to the economy are strong.
The monthly current account has moved into surplus as imports collapse, helping to lessen the need for foreign capital. Yet there are growing concerns that the central bank will be strong-armed into cutting rates prematurely. There has been no implementation of structural reforms and so the medium-term outlook remains poor.
President Erdogan continues rule the nation with an iron fist. Recently, Turkey has launched military operations against US-backed Kurdish rebel forces in both Syria and Iraq, which risks further inflaming tensions with the US. Erdogan still blames cleric Fethullah Gulen for the attempted coup in 2017 and continues to press the US for his extradition.
This material is provided solely for informational purposes by Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) to recipients who are classified as institutional or sophisticated investors, or as Professional Clients or Eligible Counterparties if in the European Economic Area (“EEA”). BBH is an independent FX research provider and this communication should not be construed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency, security, other asset class or any particular investment strategy. This material does not constitute legal, tax or investment advice. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code or for promotion, marketing or recommendation to third parties. This information has been obtained from sources believed to be reliable that are available upon request. This material does not comprise an offer of services. Any opinions expressed are subject to change without notice. Unauthorized use or distribution without the prior written permission of BBH is prohibited. This publication is approved for distribution in member states of the EEA by Brown Brothers Harriman Investor Services Limited, authorized and regulated by the Financial Conduct Authority (FCA). Please be advised that any analysis of individual countries, currencies, securities or other asset classes contained herein, including, but not limited to, rankings contained in BBH Country Risk Ratings, FX Risk Rankings and Equity Risk Rankings, should not be considered sufficient information upon which to base an investment decision. Such analysis is intended to serve as a preliminary screening tool, which should be supplemented by additional research.
This material contains “forward-looking statements” which include information relating to future events, projected future performance, statements regarding intentions, strategies, investments, expectations, the competitive and regulatory environments, predictions, and financial forecasts concerning future foreign exchange activities and results of operations and other future events or conditions based on the views and opinions of BBH. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements.
Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time the statements are made and/or BBH’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in, or suggested by, the forward-looking statements. Actual results of activities or actual events or conditions could differ materially from those estimated or forecasted in forward-looking statements due to a variety of factors.
There are risks associated with foreign currency investing, including but not limited to the use of leverage which may accelerate the velocity of potential losses. Foreign currencies are subject to rapid price fluctuations due to adverse political, social and economic developments. These risks are greater for currencies in emerging markets than for those in more developed countries. Foreign currency transactions may not be suitable for all investors depending on their financial sophistication and investment objectives. The services of an appropriate professional should be sought in connection with such matters.
BBH, its partners and employees may own currencies discussed in this communication and/or may make purchases or sales while this communication is in circulation.
Information has been obtained from sources believed to be reliable and in good faith. Sources are available upon request. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Any opinions expressed are subject to change without notice. This material has been prepared for use by the intended recipient(s) only. Unauthorized use or distribution without the prior written permission of BBH is prohibited. Please contact your BBH representative for additional information.
BBH is a service mark of Brown Brothers Harriman & Co., registered in the United States and other countries. © Brown Brothers Harriman & Co. 2019. All rights reserved.
January 2019. IS-04549-2019-01-02