Transcript
Neil Staines
Welcome to Portfolio Managers' Questions, a production of Eurizon SLJ Capital that takes a look at the macroeconomic backdrop and specific areas of interest across FX, fixed income, credit and equity space from a portfolio manager's perspective. Recorded for professional investors.
My name is Neil Staines and I am Senior Portfolio Manager with Eurizon SLJ, and today I'm joined by Alan Wilson, Portfolio Manager in Emerging Market Debt and FX.
Welcome, Alan.
Alan Wilson
Hi, how are you doing?
Neil Staines
Good, thank you.
So, starting from a high level, top down macro view of the world, if you will, last time we spoke, we discussed some of our core macro thematic views, such as the positive global growth outlook despite persistent covid pressures, but a recovery that, unlike the synchronous recovery from the GFC [global financial crisis in 2008], is likely to demonstrate significant global economic differentiation. A differentiation that's exaggerated by the supply demand imbalances and, of course, differentiated by the significant monetary and fiscal response. How are you seeing that play out across EM?
Alan Wilson
Thanks, Neil. I agree. Actually, I think that the recovery we're seeing now is completely different to the one that we've seen in the GFC. There's going to be significant regional divergences, and I think the United States will be the way; it's the most dynamic, large economy in the world, and I think it will recoil from the pandemic stronger and more resilient. But underneath the figure of the US economy, we've got the ongoing fiscal stimulus, which just continues to grow. So I think the US is likely to be on course for its fastest pace of growth in the last 50 years.
But I don't think the US is the only case of exceptionalism in the world at the moment. China has largely passed the recovery baton to the US, but I still see both economies outstripping the rest of the world over the course of this year. China is further ahead in its recovery from the pandemic, but still stimulating - both fiscal and credit policy remains stimulative. So I think China is in a good place alongside the US.
In terms of the emerging markets, I think they're very likely to lag these two big economies. While emerging markets should continue to benefit from increasing cyclicality and ongoing demand for commodities and construction machinery, I think others will remain highly exposed to vaccine shortfalls, shallow economic recoveries and potentially fiscal slippage as a result.
Drawing this macro calibration together, I think it's still a challenging backdrop for the emerging markets. US and, to a degree, China exceptionalism is still going to result in tests of the accommodative policy stance of the Fed, and I think that could result in core market yield pressure and episodic pressure on emerging markets.
So for us, we remain selective. We continue to favour emerging markets which have strong underpinnings to withstand the more challenging backdrop. And those are the emerging markets which should have a strong beta to the cyclicality and the demand for commodities and capital goods. And we're also looking for emerging markets which have strong fiscal dynamics, solid fiscal dynamics, the monetary policy capacity, as you mentioned, and also steeper curves and higher real yields.
Neil Staines
Absolutely, I think it's a fascinating backdrop at the moment. Certainly we talk about differentiation in relation to the US economy, and the US rates are a really key part of this. It's it's all very well for higher steeper curves, which we would agree with, in the US, and you can argue, you can make the case that actually yields are still very low relative to the US recovery situation, but that that base level of US rates may not be so accommodative for the rest of the world, particularly as that rallies.
And I think, from a macro perspective, certainly from a DM [developed markets] perspective, we could apply a similar backdrop across Europe with bund yields recently rallying up towards the heady heights of zero. But you know, those levels putting pressure on peripheral yields and even ultimately, potentially credit spreads. So I think that that's the differentiation playing out on a number of levels throughout.
Alan Wilson
I agree. I think the core market yields are the key here for emerging markets. And I agree also that, you know, they haven't actually moved that far. When you when you look at the recovery which is playing out in the US, as I mentioned before, it's probably going to be on course for the fastest pace of growth in almost 50 years. So I think yield pressure is probably upwards than downwards here.
For us, that should result in episodic pressure points in emerging markets. That's not to say I'm too gloomy; 'cautious' is the right word. But I still think there's money to be made in our asset class. And I think it's just all about that selectivity. We're looking for the markets that have the right insulation to essentially protect them from this challenging backdrop.
So, I think cautious but selective in emerging markets is the right way to look at it, in my view.
Neil Staines
Great stuff. In the macro space obviously, as we've mentioned, we are focussed on this US outperformance against the rest of DM in the pandemic, and this positive differentiation obviously favours the US. But more recently, we've had the surprise big miss in in the US employment report, and that adds complication to the expression of this view.
At the same time, the increasing debate and recently uncertainty amongst some of the Fed commentators about the impact of inflation and the relative transiency of inflation. I think, our core view, that inflation is going to feel very real ex ante, but the reality of sustained inflation ex poste is not really a strong argument from our perspective.
Is this kind of implicit taper talk delay a positive for the EM backdrop, Alan? How do you see that evolving?
Alan Wilson
I think you're spot on again. The employment numbers at the tail end of last week were a big surprise. It's certainly wrong footed a lot of the market by all accounts.
I would use the word 'tumultuous' to describe the first quarter for emerging markets. But I think as we've seen a little bit of stability in core market yields and in the dollar - and I think that is going to be reinforced by the data miss that we've seen last week - there has been some signs of stability creeping into emerging markets. And, as we mentioned at the start of the conversation, the core market yields and the dollars is almost a pressure release valve for the emerging markets. The emerging market pressure has started to come off a little bit, and we have seen some tentative toe-dipping into the asset class. I would describe it is more arithmetic or mechanical, if anything, based on these core market moves. I would still say that the broader tone in emerging markets is cautious.
I think it's worth checking out HSBC's positioning and flow data; it is really good for a sort of canary in the coalmine for demand in emerging markets, and it shows that the flow into the asset class is still light and there are still record cash balances on hand. So to me, I still think the overall environment is cautious, even though we have seen a step back from the concerns around the taper tantrum. I would actually say the the concerns of the emerging markets are probably a little bit more idosyncratic at the moment as well. You've had some pretty negative comments, or developments actually, in LatAm; some political risk flaring up in Colombia and El Salvador. So I think that when you take all of that together, there has been some release of the pressure valve. But there are still things happening on the ground which do continue to cloud emerging markets. All in all, it is still quite cautious, in my opinion.
Neil Staines
That's great, thanks very much Alan.
So just moving on from there, going back towards the virus and vaccine rollout, as you mentioned. There are a number of Fed commentators who have more explicitly linked the progress towards containment, if you will - not talking about eradication, but of containment - of the virus to be more of a determining factor in terms of monetary policy going forward. The picture in the DM world is very much one of a recovery from the pandemic, and there is certainly a closer light at the end of the tunnel, if you will.
Are there any areas of specific concern from a pandemic perspective for you, from an EM perspective? Or areas where you're a little more cautious? And how does that fit with the monetary normalisation that we've started to see across some of the EM central banks?
Alan Wilson
Just to reiterate the point at the start of the call: I think that there are elements of emerging markets which will likely lag the recovery in the core. And I think a lot of that has to do with the lack of vaccination availability in those countries.
One case in point is India at the moment. And that has been in the headlines, but still remains a concern for us. The covid case count continues to surpass previous local and global peaks, as the virus moves from western and central India to eastern and southern India. The fatality rate remains low optically. But the sheer size of mortalities, which is around about 3,500 people per day, is really high and quite concerning. The total reported cases in India now exceed 20 million, and the country is currently seeing an average of 380,000 cases per day. So some quite worrying numbers there.
Thankfully, over the most recent few days, weeks, you the cases have fallen a little bit and the reproduction rate has inched a bit lower. So there are some green shoots there. But I think, to your point, work has to be done in the vaccination rollout. In India specifically, it's running well below the global average, and that's all to do with the supply side constraints. For India to vaccinate critical mass, it would need to double its current rate of vaccinations to over 5 million a day, and we're just not there yet. So I think imports of new vaccines like Johnson and Johnson and even the Sputnik vaccine could help get India to a more sustainable plane.
Even so, taking that quite negative outlook for the vaccines and the pandemic in India to one side, economic activities actually remain quite resolute. Manufacturing PMI in particular has been really, really strong. So I think it's actually worth probably focussing on the mobility data. You can actually see that coming off a little bit in India. So all in all that are some potential downside risks in India worth keeping an eye on, and that is all driven by the covid dynamics that we discussed.
I think the case count in India is really, really important for markets, particularly in the case of the INR. That is probably one of the most favoured EMFX positions of this year. And it's one we actually still like, we're sort of bias to fade the vaccine and covid headlines and still be bias to be long the INR. We think India is a really strong structural case and it should benefit well from the global upswing that we're seeing at the moment.
Neil Staines
Thanks for that very much, Alan. There's plenty there to reflect upon and focus on going forward.
Thank you, everybody, for joining this edition of PMQs. Further insights can be found via our website, at eurizonsljcapital.com/insights, and we look forward to you joining us again next time.
Many thanks. Thanks, Alan.
Alan Wilson
Thanks Neil.
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