Emerging Markets: Stirred, But Not Yet Shaken

Market Context and Recent Performance:

• Risky assets performed strongly through February 2026 but reversed gains following an oil price spike triggered by the Iran conflict.
• The market is currently pricing in an inflation shock rather than a cyclical growth shock.
• Rates curves have shifted upward, removing expectations for rate cuts in the US and UK and adding rate hike expectations.
• Traditional portfolio hedges have underperformed, including long duration interest rates, long gold positions, and the Swiss franc.
• Equity sell-offs have lacked a clear tilt toward cyclical growth assets (e.g., Australian dollar, copper), suggesting the move is not yet a growth recession play.
• Analysts identify a "growth shock" as the next potential market driver if the conflict persists or causes physical shortages.

Dollar Dynamics:

• The US dollar has strengthened due to two converging factors: a global risk-off unwind and US terms of trade advantages.
• The US benefits from being on the "right side" of the terms of trade divide (higher energy prices act as a net positive relative to import/export costs).
• Currency differentiation is shifting from a pure risk-unwind trade to a fundamental trade based on energy import/export balances.
• The dollar is expected to remain supported as long as energy price pressure persists.

Emerging Markets (EM) Analysis:

• Strong pre-conflict EM momentum was interrupted by an unwind of concentrated positioning (e.g., Korea, which had performed exceptionally well prior to the shock).
• Many EMs, particularly in Asia and Central/Eastern Europe, face direct balance of payments pressure as energy importers.
• Goldman Sachs maintains a 10–12% upside forecast for EM equities, driven primarily by strong earnings growth rather than multiple expansion.
• Korea is highlighted as a growth proxy due to the AI semiconductor supply chain, with this structural trend expected to endure absent a global recession.
• Energy-exporting EMs (e.g., Brazil, South Africa) are currently under pressure from risk aversion but are expected to recover as the shock de-escalates.
• Structural tailwinds for EMs include:
  • Dollar Trajectory: The dollar is viewed as overvalued and expected to erode over the medium term, aiding EM assets.
  • Fundamental Resilience: EM macro fundamentals (growth, inflation, fiscal deficits) remain healthier than in previous cycles.
  • Allocation Trends: Global fund allocations to EMs sit at ~10%, below the ~12% benchmark weight, indicating underweight status and room for inflows.

Forward-Looking Outlook and Conditions:

• Commodity markets currently price the conflict as short-duration (weeks rather than months).
• A prolonged conflict would necessitate a re-evaluation of growth estimates and could trigger physical supply shortages.
• Goldman Sachs projects that once the inflation shock is quantified and de-escalation occurs, the focus will shift to pricing the subsequent growth damage.
• The firm expects the conflict will not fundamentally alter the long-term positive narrative for emerging markets provided it does not become a prolonged disruption.