Global central bankers, ministers of finance and representatives from the private sector and civic groups gathered in Washington, D.C., last week for the Annual Meetings of 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. Investors point to improvements in growth, lower inflation and contracting current account deficits as evidence of EM’s resilience to global shocks.
2. Despite a bullish stance overall in emerging markets, positioning does not seem to be stretched. Investors are reluctant to be overly long given macro risks but are also loath to reduce risk for fear of missing out on further upside. Investors are favoring EM local debt given its relative value versus developed-market bonds and its underperformance versus EM hard-currency debt in recent years.
3. In terms of risks, China's policy stance post–Party Congress and 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 normalization and European Central Bank (ECB) balance sheet reductions are not setting off alarm bells.
4. Investors are unsure about the path of the U.S. dollar but expect oil prices to stay range-bound. Commodities appeared far from top-of-mind among participants, in contrast with what we’ve observed in many recent IMF meetings.
5. EM flows could moderate next year but are unlikely to reverse, with further inflows expected before 2017 comes to a close. Growth in exchange-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 able to act counter-cyclically (i.e., to ease while the Fed is hiking); Russia and Brazil, for instance, have room to loosen monetary policy further. There was debate, however, as to whether low inflation is a locally or globally driven phenomenon (a point we also discussed in our Cyclical Forum).
7. Uncertainties about the future of the North American Free Trade Agreement (NAFTA) are increasing, and while the implications for Mexico’s economy are difficult to quantify, a U.S. withdrawal from NAFTA would likely crimp growth there too (Mexico is the No. 1 export destination for six U.S. states and the No. 2 destination for another 32). The upcoming presidential elections in Mexico next July further complicate matters, with the path for monetary policy and the currency dependent on the outcome and interplay of local politics and trade negotiations. Should NAFTA head for the scrap heap, we expect Mexico to mitigate the impact by accelerating trade agreements with EU, Trans-Pacific Partnership (ex U.S.) and Mercosur member nations.
8. Venezuela, to quote Winston Churchill, is still “a riddle wrapped in a mystery inside an enigma.” Hopes that President Nicolás Maduro’s administration and his United Socialist Party of Venezuela would cede ground to the opposition in the gubernatorial elections were dashed over the weekend, with the Chavistas digging in their heels as a negotiated regime change becomes more remote. Assuming timely payment on upcoming PDVSA (Venezuela’s state-owned oil and gas company) bond maturities, the next significant repayment “hump” is not until August 2018. Key developments to watch will be the path of U.S. and European sanctions and the rapid contraction of oil production (the country’s key source of foreign currency for imports).
9. While the cyclical upswing in Latin America is spreading and becoming more synchronized, reform momentum is more divergent. Participants expect Brazil to keep pushing ahead with reforms before next year's elections and Argentina to refocus on fiscal and structural measures once the October midterms conclude. Investors were most bullish on Latin America among the emerging markets, with the majority expecting to add risk near-term in the region’s local markets and hard-currency debt.
10. Outside of Latin America, countries with an IMF lifeline, particularly Egypt and Ukraine, remain in vogue but face close scrutiny given the extent of investors’ involvement. Policymakers in Sub-Saharan African nations painted a mixed picture, indicating that when the tide of EM inflows goes out, there will likely be plenty of dispersion in how these countries perform.
In sum, we think risk assets are likely to grind higher (uncertainties in Mexico notwithstanding). Having said that, global policy shifts and geopolitics may test the current low volatility and provide attractive entry points into the asset class. We think investors will do well to stay liquid and keep dry powder to take advantage of dislocations.
For more of our views on global economies and markets, see our latest Cyclical Outlook, “As Good as It Gets.”
Yacov Arnopolin, Lupin Rahman and Vinicius Silva are emerging markets portfolio managers and contributors to the PIMCO Blog.