domingo, 31 de diciembre de 2017

Emerging Markets Don't Control Their Own Destiny

Their fate is in the hands of big central banks. So much for the "decline of the West."

Daniel Moss

It still doesn't pay to buck the Fed.

For all the hype about the decline of the West, it still largely controls whether emerging markets thrive or suffer.

The broad global pick-up in growth this year propelled emerging markets toward the biggest gains in stocks and currencies in almost a decade. China's debt binge did add ballast to the global expansion, and the country's neighbors are vulnerable to any sudden blow-up there, as implausible as it is. (A gradual unwinding, guided by the state, seems more likely.)

But in a year cluttered with commentary about the retreat of the U.S. and the contentious divorce proceedings between Britain and the EU, it's worth remembering that in some arenas the Old still punches way above its weight relative to the New. The withdrawal of monetary accommodation in the U.S. and the euro zone enters a new phase in 2018, and how that plays out will matter far more than anything emerging markets do themselves. Even Japan may begin easing up on liquidity.

The Fed is further ahead than anyone. Unlike in past Fed interest-rate cycles, big emerging market countries like Indonesia and Brazil have been able cut borrowing costs. That's partly because inflation has been relatively low, and also because the Fed's actions have been predictable; forward guidance has been a reliable script. Here's the risk: What if the Fed feels it needs to be more aggressive in 2018 than indicated, because unemployment gets so low that wages and inflation pick up?

Emerging markets can probably handle four Fed hikes next year, rather than the three indicated by the celebrated "dot plot." The tension is that four aren't priced by investors. Some models even show less than two steps baked in. A shift in pricing could spell volatility in emerging market assets, says Luis Oganes, head of global emerging market research at JPMorgan. Things might start to get hairy if the Fed has to again do more in 2019.

The European Central Bank is on track to end quantitative easing in September. It doesn't say that baldly, only that the current whittled-down program of 30 billion euros a month runs until September. But you can't be as optimistic as Mario Draghi was last week, and then say you need more QE beyond the current horizon. It's a gradual phasing out, but when it ends, a chapter in monetary history is over.

Japan, for one, seems closer to the end of QE than to the beginning, even if no immediate cutoff is likely.

The second big threat to EM also originates in the developed world. And it just wouldn't be December 2017 without mentioning bitcoin or the flattening U.S. yield curve, right? The yield curve gets the prize. While its record as a predictor of recession isn't perfect, it might be telling us something is amiss. There is little indication from elsewhere that a recession is approaching. Something to watch, cautions Oganes, is whether the curve points to reduced lending appetite from banks, which would in turn erode credit supply and constrain growth.

Political risks are scattered through individual countries, principally elections, though not on a level that is likely to prove systemic. Elections in Mexico and Brazil top the list. On the former, left-wing populist Andres Manuel Lopez Obrador is ahead in most opinion polls, and some of his positions are hard for investors to stomach. That said, Lopez Obrador is trying to placate critics. He's made several visits to New York recently and this month said he would name Carlos Urzua as finance minister if he wins. Urzua is a former finance minister of Mexico City and well respected. Lopez Obrador may be less of a revolutionary than investors fear.

Then again, perhaps politics doesn't matter so much anyway. After all, 12 months ago one of the most-cited risks was that Donald Trump would start a trade war and that globalization was dead. Either of those would have gravely wounded emerging market assets.

Good thing the developed world central banks are really running things. China and India are rising, but can't yet bend the financial world to their will consistently. It still doesn't pay to fight the Fed.

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