Interview, Fireside Chat
Positive structural case for EM won’t collapse under a few Fed hikes
- Global inflation is projected to decline by 2027 due to falling oil prices and favorable base effects from 2026, leading to lower global rates and a return to a weaker dollar.
- The team forecasts three Federal Reserve rate hikes by year-end in the last quarter, predicting rates will return to early 2025 levels, with no further changes expected next year.
- Current market pricing is deemed insufficient, as it accounts for minimal hikes rather than the predicted three, which the speaker believes may not be fully adopted by investors yet.
- Near-term headwinds for emerging markets (EM) are expected through the summer and into the autumn due to strong U.S. data, potential dollar strength, and the "US exceptionalism" driven by AI themes.
- Long-term expectations favor a structurally weaker dollar over the next couple of years, positioning long EM positions as a recommendation once policy clarity emerges.
- A sharper pullback in U.S. tech stocks could weaken the dollar and benefit EM, though a very sharp market move typically triggers risk-off sentiment detrimental to EM assets.
- Chinese domestic demand is expected to remain very weak, with growth relying on exports; however, low Chinese interest rates may encourage exporters to hold assets in foreign currencies, pressuring the renminbi.
- The Chinese currency trade is anticipated to face pressure over the next several months, with expectations of some CNY weakness against the dollar, though it remains viewed as cheap on a one-year basis.
- Emerging market fundamentals are considered stronger than several years ago, with current inflows viewed as tactical buying of dips that could offset a decade of structural underweighting.
- AI is constructive for EM only if it boosts global productivity broadly; a U.S.-centric productivity shock could structurally strengthen the dollar and hurt EM assets.
- Trade tensions between China and Europe pose a risk of negative growth impacts on the rest of the world, potentially cementing U.S. outperformance and weighing on EM.
- Brazil's outlook has been revised to 1.3% growth for next year from 2%, with higher-than-expected inflation and more rate hikes expected alongside less growth, scaling back previous expectations for an easing cycle.
- The Brazilian election deadline of August 15 introduces volatility, with polls showing a tie between Lula and Flavio Bolsonaro; potential fiscal adjustments by either candidate could lead to declining interest rates, particularly under Flavio.
- Investors are currently avoiding structural EM positions due to election volatility in Brazil and the uncertainty surrounding potential Fed hikes, though carry trades in currencies and bonds are expected to remain attractive.
- If the three predicted Fed hikes escalate into a larger hiking cycle or if trade tensions flare, the structural bullish view on EM could break down.
- Base effects and favorable conditions are expected to eventually drive a return to a weaker dollar, suggesting that weakness driven by Fed hikes in the short term could serve as a buying opportunity leading into 2027.
- The speaker identifies risks from the Iran war, which could have a longer-lasting global inflationary impact, potentially leading central banks to tighten policy negatively for global growth, with the U.S. impact being more pronounced.