emerging markets: Strong dollar and high interest rates a classic tough environment for emerging markets: Adrian Mowat
Would you agree with our assessment that Thursday morning, there is good and bad both depending on whom you are asking?
Yes, the good is that the US economy continues to have strong momentum and household sectors benefiting from a strong labour market. Obviously, the bad news is that this means US rates remain higher for longer, the dollar tends to be a firm situation, particularly in contrast to some of the Asian currencies like the yen, where the Bank of Japan is going to continue to run a very accommodative monetary policy. This strong dollar and high interest rate environment is a classic sort of tough environment for emerging markets.
Do you think this entire risk-on rally in emerging markets now could come to a pause naturally because of global macros? It has been a good year in general for emerging markets.
Well, it has not really because the largest emerging market which is China, is having a very poor year. And so out with China, we have seen a little bit of strength in some of the largecap tech stocks in Taiwan and Korea. India has proved to be a bit more resilient. But it is not a strong environment for emerging markets and because China is doing poorly, when I speak to emerging market fund managers, they are trying hard not to have redemptions. In many cases, they are having redemptions. I think to some extent, India is suffering from the problems in China, because that is leading to people being very circumspect about investing in emerging markets.
If the template for the US is going to be strong, indirectly what do you think that means for the world because if the biggest economy in the world is growing, that is actually not bad news?
No, it is good. To have a global economy that continues to expand maybe at a more modest pace next year, in itself is not a bad thing. Growth within your economy in India remains quite robust. We are seeing okay activity in Southeast Asia and the big economies like Vietnam, Indonesia etc.
In Central America, there is a little bit of easing going on. So there is some good news out there. But I think there is a very important market that we need to talk much more about and that is the long end of the bond market in the United States. Bond yields have now moved up to around the 4.4% level. The yield curve in the US remains the most inverted that we have ever seen since Volcker was the US Fed chief. When Volcker was in power, short term interest rates went as high as 20%. And there was an inversion that arithmetically was a bit bigger than the current one.
So we have got a US economy that looks more resilient and an inverted yield curve. People put a great deal of store behind the yield curve as if it is a divine indicator that cannot be argued with. I would suggest that the yield curve is wrong. The US bond yields need to move higher. And to some extent, we are seeing that going on. As people say, look if I can get 5.25% in a money market fund, why am I getting a lower yield taking on duration risks when the economic data looks good?
I think for this year, it is going to be a sort of pain trade with bond markets being weak, bond yields moving higher, and as bond yields move higher, then the key discount rate is moving higher. That puts a little bit more pressure, particularly on asset markets like infrastructure, property, which are very sensitive to cap rates, to discount rates.But Adrian, does that at large also spell bad news for equity markets as an asset class?
I think it impacts equities where the discount rate is important. But I am much less worried about the listed equity market. I would be worried about private equity and property markets. After the moves that we have seen in the US equity market – I know a lot of people want to just put it down to AI – but for the very largecap stocks, their free cash flow generation has accelerated meaningfully and so there has been a good fundamental driver.
If the global economy continues to expand, then the earnings outlook is probably more resilient than people expect. So equities would rank much higher than bonds. But yes, be sensitive that you have got the right conservative discount rates when you are looking at valuations.