Set against a constructive global backdrop, the overall tone at the mid-April meetings of the International Monetary Fund and the World Bank Group in Washington, DC, was optimistic, albeit mindful of the differentiated political and idiosyncratic risks across emerging markets (EM). PIMCO also is broadly constructive on emerging markets, although we believe the greatest opportunities within the asset class will be realized by focusing on alpha potential in individual markets and, in a broader perspective, by offering a source of portfolio diversification potential.
We outlined our 2019 outlook for emerging markets in a March Viewpoint, “Emerging Markets Outlook: The Wealth of Nations.” We presented our supersecular views earlier this month in a more technical In Depth article, “Emerging and Developed Markets: So the Last Shall Be First?”
Here are 10 takeaways from the IMF/World Bank meetings, which included central bankers, finance ministers and representatives from the private sector and civic groups.
- The combination of a patient Federal Reserve, Chinese stimulus and a reduction in U.S.–China trade tensions pointed to a constructive global backdrop for risk assets. Many attendees came away relatively bullish and looking to add risk. While generally positive on EM beta, they saw increasing differentiation across countries. These views were underpinned by upcoming elections (e.g., in India, South Africa, Argentina, Uruguay and Ukraine), high external vulnerability risks (e.g., Turkey), and policy uncertainty, with new governments in Mexico and Brazil.
- Most participants expected China to avoid a hard landing through a mix of domestic stimulus and progress on U.S.–China trade talks in line with our baseline view. While discussions focused on the fiscal multiplier of Beijing’s current stimulus, most China economists agreed that the spillover effects for emerging markets would be more limited than in previous rounds. They expected trade talks to continue to simmer rather than boil over. The main risk they saw was that China doubles down and demands the removal of tariffs, requiring a politically difficult capitulation by Washington.
- As for emerging markets, many investors said equities and credit were their top picks for 2019 returns given the combination of inflows and healthy balance sheets. Dedicated EM investors, however, noted the generous risk premiums in EM local and foreign exchange (FX) assets but were cautious given higher volatility and lower inflows, and the use of FX as the adjustment valve for shocks.
- Brazil by far was the consensus favorite for 2019, a view underpinned by the passing of pension reforms that are expected in the second half of 2019. Nevertheless, we see political risks and positioning as skewed to the downside in the short term, particularly as growth disappoints – eroding an important part of the supportive thesis for Brazilian assets at the start of the year.
- Many participants remained concerned about Mexico’s political transition as they await further details on the government’s support for Pemex in coming weeks. Our base case is a kick-the-can solution that won’t entirely resolve the company’s problems but should keep Mexico’s credit deterioration on a steady (as opposed to rapidly) declining path. With the lack of clarity on Pemex, the United States–Mexico–Canada Agreement (USMCA), and slowing growth amid moderating inflation, the Bank of Mexico (Banxico) is likely to be cautious on its policy rate path.
- Regarding Argentina, discussion focused on the potential for President Mauricio Macri to win a second term in the October 2019 elections despite a weak economy, high inflation and erosion of real incomes. Political analysts noted that candidate and ex-president Cristina Fernández de Kirchner is a divisive figure within the Peronist block and has an approval cap among voters. With the IMF funding government liabilities through all of 2019 and part of 2020, our concerns on near-term liquidity risks are shifting more to medium-term debt sustainability under a potential Kirchner regime.
- Many delegates and observers came away cautious on Turkey following the announcement of the government’s bank recapitalization and rebalancing plan. We view the main hurdle as being the lack of a coherent and transparent policy framework and game plan for rebalancing the economy. In addition, fragile U.S.–Turkey relations in the face of Russian missile purchases, as well as ties with Venezuela and Iran may keep the risk premium embedded in Turkish assets elevated.
- The consensus view was that sanctions will continue to hang over Russian assets like the Sword of Damocles. However, existing paper is likely to be grandfathered and local issuance may be spared altogether. PIMCO’s base case is that although sanctions serve as an important policy and political tool in the U.S., the impact of this well-telegraphed threat would be mild for Russia’s markets and economy.
- Participants generally viewed IMF programs in Egypt, Ukraine and Ecuador favorably. We believe Egypt’s successful macroeconomic adjustment program has a good chance of being followed up by a non-funded program when the current program expires in November. In Ukraine, political risks around the presidential and parliamentary elections remain high; but Kiev’s high external financing needs are expected to provide a check against going off-track with the IMF’s program. Meanwhile, the new program in Ecuador appears to have good government ownership with a focus on reducing its twin deficits.
- Finally, in Venezuela, with armed militias providing support, socialist president Nicolás Maduro has been difficult to dislodge. But with oil production firmly below 1 million barrels per day, down from about 2.3 million barrels per day five years ago, and the economy in collapse, we believe regime change remains a question of when, not if.
For PIMCO’s current view on emerging markets, please see, “Emerging Markets Outlook: The Wealth of Nations.”
Yacov Arnopolin, Lupin Rahman and Vinicius Silva are portfolio managers on the emerging markets team. Gene Frieda is a global strategist.