Rory Smith

Market Commentary

For the week ending 07 September 2018
Report by Rory Smith
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Rory Smith

Emerging market assets have remained an area of focus in recent weeks, with prices declining in response to a stronger US Dollar and country specific issues in Turkey and Argentina, with the latter requesting financial assistance from the International Monetary Fund.

This weakness – which has weighed particularly on emerging market equities – is in part a side effect of the strength of the US economy. A robust US economy has allowed the Federal Reserve to continue to raise interest rates. This has attracted inflows into the US economy, strengthening its currency, and weakening emerging market currencies. It has also put pressure on emerging markets which have borrowed in US Dollars, by increasing the cost of servicing this debt.

Ongoing trade tensions, which could slow the global economy, are not helping sentiment towards the asset class either. Whilst progress appears to have been made by the US and Mexico on renegotiating the North American Free Trade Agreement (NAFTA), Canada appears some way of an agreement. It is also possible that in coming days the US introduces an additional $200billion of tariffs against China.

US economic data this week included the ISM manufacturing survey, which reached a 14-year high. It follows an upward revision to second quarter GDP (to 4.2% from 4.1%) and very strong consumer confidence data at the end of August. This strong data reinforces the likelihood that the US Central Bank will proceed with two further increases to interest rates this year, which may provide further support to the US Dollar. It would, therefore, appear that the macro conditions which have been weighing on emerging markets are unlikely to dissipate in the near-term.

That said, clearly some of the bad news is in the price, with yields on emerging market bonds, relative to developed market equivalents, at two-year highs. Emerging market currencies on an aggregate basis (as measured by the J.P. Morgan Emerging Market Currency Index) now stand at an all-time low, and equity valuations are below their historic average. An easing in trade tensions, or signs that the US Central Bank could stop or pause interest rate hikes, would renew investor interest in the space.

Returning to our domestic market, UK assets and headlines remain sensitive to Brexit developments. On Wednesday, news that Germany is prepared to ‘accept a less detailed agreement on the UK’s future economic and trade ties with the EU in a bid to get a Brexit deal done’ led the Pound to jump 1.2% against the US Dollar. Whilst subsequently refuted by Germany, the Pound held onto its gains, potentially signalling that investors are slightly more optimistic that a deal between both sides can be agreed before Brexit day.