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The Great Divergence

  • The global investment climate is characterized by a divergence between the US and UK, which will likely move to hike rates next year, and Japan and the Eurozone, which are still deeply engaged in unorthodox policies to support their economies.
  • Investors are best served by focusing on the signal emanating from the leadership at the Federal Reserve (Yellen, Fischer and Dudley), rather than the cacophony of views from the regional presidents.
  • The ECB has unveiled two new programs to arrest deflation and rekindle lending: the Asset Quality Review and bank stress tests. After these programs, the ECB will assume supervisory responsibility for the large European banks.
  • The controversial retail sales tax in Japan has had a greater and longer-lasting economic impact than officials anticipated. The weakness of the yen in late Q3 will likely renew price pressures that had stabilized in recent months. This will take pressure off the BOJ to provide more stimulus, and the government will likely respond to the weaker growth with a supplemental budget.
  • Volatility in the foreign exchange market has bottomed, which means that asset managers may need to be more sensitive to currency fluctuations than they have in the recent past.

 

Emerging Markets Overview: FX policies and commodity prices will drive EM performance

  • The EM rally stalled in Q3, and will have trouble extending into Q4. In the short-term, we continue to favor Asia and Latin America over EMEA currencies, but stress that investors should differentiate amongst EM: there are idiosyncratic risks across countries, and with potential bumps expected in the general investment climate, focusing on fundamentals will be key.
  • Other factors in play include the vast differences in FX policies across EM, as well as falling commodity prices, which will benefit Asia and EMEA over Latin American countries. Continued easing by the BOJ and ECB will give renewed life to the search for yield, a strong benefit for EM debt.