2015 closed on a weak note for Emerging Markets and global risk assets more generally. Unfortunately for investors betting on a ‘January Effect’ turnaround, markets over the first week of the New Year have been similarly disappointing with renewed concerns about the three biggest drivers of emerging market (EM) risk last year: US Federal Reserve policy, oil and commodities pricing, and Chinese growth. While none of these factors seem particularly confidence-inspiring at the moment, the huge adjustment we have already seen in EM asset prices and currencies should provide a considerable cushion for the year ahead and be a limiting factor for expected volatility relative to 2015.
After a brief rally triggered by rising tensions between Saudi Arabia and Iran, oil prices have continued to fall on weak global demand and rising supply and inventories. The end of the ban on US exports should further contribute to the global glut and has already narrowed the spread between West Texas Intermediate (WTI) and Brent to near parity. We maintain a downside bias to our expectations for oil this year but not significantly so. For some producers such as Colombia, the worst of the pain is likely already behind, with oil revenues linked to producer company margins which have declined more than the actual commodity’s price. FX weakness has also provided a significant offset in terms of local currency revenues and external balances.
In terms of the two biggest engines of global growth, United States and China, we are somewhat more optimistic and believe that an unexciting muddle-through scenario is most likely. For the US, this means that economic growth is not accelerating significantly, and the pace of Fed tightening is likely to remain very modest. However, there is enough momentum in employment and consumer spending to sustain investor risk appetite, particularly for higher quality assets. In China, weak manufacturing data triggered a rout followed by heavy government intervention in the stock market.
This is additional evidence that the economic transition from manufacturing and exports to domestic consumption is proceeding and not indicative of a breakdown in Chinese economic activity.Download to read more