Global central bankers, ministers of finance and representatives from theprivate sector and civic groups gathered in Washington, D.C., last week forthe Annual Meetingsof the IMF (International Monetary Fund) and the World Bank Group.
Below are 10 key investment takeaways gleaned from this year’s discussions.
1. The outlook for emerging markets (EM) remains constructive. Investorspoint to improvements in growth, lower inflation and contracting currentaccount deficits as evidence of EM’s resilience to global shocks.
2. Despite a bullish stance overall in emerging markets, positioning doesnot seem to be stretched. Investors are reluctant to be overly long givenmacro risks but are also loath to reduce risk for fear of missing out onfurther upside. Investors are favoring EM local debt given its relativevalue versus developed-market bonds and its underperformance versus EMhard-currency debt in recent years.
3. In terms of risks,China's policy stance post–Party Congressand buildup of corporate balance sheet leverage were areas of focus,although most investors do not expect a major crisis or “credit cliff”event.Federal Reserve policy normalizationand European Central Bank (ECB) balance sheet reductions are not settingoff alarm bells.
4. Investors are unsure about the path of the U.S. dollar butexpect oil prices to stay range-bound. Commodities appeared far from top-of-mind among participants, in contrastwith what we’ve observed in many recent IMF meetings.
5. EM flows could moderate next year but are unlikely to reverse, withfurther inflows expected before 2017 comes to a close. Growth inexchange-traded funds (ETFs) and passive investing is viewed as a risk,given their ability to act as marginal price-setters on small volumes,creating volatility.
6. EM central banks are meeting their inflation targets and are thus ableto act counter-cyclically (i.e., to ease while the Fed is hiking);Russiaand Brazil, for instance, have room to loosen monetary policy further.There was debate, however, as to whether low inflation is a locally orglobally driven phenomenon (apoint we also discussedin our Cyclical Forum).
7. Uncertainties about the future of the North American Free TradeAgreement (NAFTA) are increasing, and while the implications for Mexico’seconomy are difficult to quantify, a U.S. withdrawal from NAFTA wouldlikely crimp growth there too (Mexico is the No. 1 export destination forsix U.S. states and the No. 2 destination for another 32). The upcomingpresidential elections in Mexico next July further complicate matters, withthe path for monetary policy and the currency dependent on the outcome andinterplay of local politics and trade negotiations. Should NAFTA head forthe scrap heap, we expect Mexico to mitigate the impact by acceleratingtrade agreements with EU, Trans-Pacific Partnership (ex U.S.) and Mercosur membernations.
8. Venezuela, to quote Winston Churchill, is still “a riddle wrapped in amystery inside an enigma.” Hopes that President Nicolás Maduro’sadministration and his United Socialist Party of Venezuela would cedeground to the opposition in the gubernatorial elections were dashed overthe weekend, with the Chavistas digging in their heels as a negotiatedregime change becomes more remote. Assuming timely payment on upcomingPDVSA (Venezuela’s state-owned oil and gas company) bond maturities, thenext significant repayment “hump” is not until August 2018. Keydevelopments to watch will be the path of U.S. and European sanctions andthe rapid contraction of oil production (the country’s key source offoreign currency for imports).
9. While the cyclical upswing in Latin America is spreading and becomingmore synchronized, reform momentum is more divergent. Participants expectBrazil to keep pushing ahead with reforms before next year's elections andArgentina to refocus on fiscal and structural measures once the Octobermidterms conclude. Investors were most bullish on Latin America among theemerging markets, with the majority expecting to add risk near-term in theregion’s local markets and hard-currency debt.
10. Outside of Latin America, countries with an IMF lifeline, particularlyEgypt and Ukraine, remain in vogue but face close scrutiny given the extentof investors’ involvement. Policymakers in Sub-Saharan African nationspainted a mixed picture, indicating that when the tide of EM inflows goesout, there will likely be plenty of dispersion in how these countriesperform.
In sum, we think risk assets are likely to grind higher (uncertainties inMexico notwithstanding). Having said that, global policy shifts andgeopolitics may test the current low volatility and provide attractiveentry points into the asset class. We think investors will do well to stayliquid and keep dry powder to take advantage of dislocations.
For more of our views on global economies and markets, see our latestCyclical Outlook, “As Good as It Gets.”
Yacov Arnopolin, Lupin Rahman and Vinicius Silva are emerging markets portfolio managers and contributors to the PIMCO Blog.