Societe Generale: Three reasons emerging markets will underperform in 2019

World currencies

Emerging market currencies and other assets are likely to continue to weaken in 2019, Jason Daw, head of emerging markets strategy at Societe Generale, said recently, tipping three reasons the segment won’t be making a comeback anytime soon.

“We’re going into 2019 with emerging market growth slowing; Chinese growth has been slowing over the past couple of months. That’s expected to continue into 2019,” Daw said at a press briefing.

“There’s now worries developing about where we are in the U.S. cycle, what’s happening with growth there. These types of dynamics are generally not conducive for EM currencies. What you see historically is that EM currencies need good growth dynamics for them to do well,” he said.

That comes after emerging market assets have already had a tough year.

Indonesia’s rupiah has fallen to levels not seen since the Asian Financial Crisis of the late 1990s, while Argentina’s peso, among the worst-performing currencies this year, starting the year at around 18.59 to the U.S. dollar, compared with levels around 38.251 last week.

Daw pointed to three reasons why it won’t be emerging markets’ year again next year.

Firstly, emerging markets have seen a lot of dollar funding since quantitative easing programs began back in 2009, he noted, citing Bank of International Settlements data showing dollar liabilities have climbed to US$2.7 trillion from US$1.5 trillion over a ten-year period.

“That level of dollar liabilities in emerging markets has never really been tested in a tightening cycle,” he said.

Secondly, over the past decade, a lot of money has flowed into emerging markets, chasing higher yields at a time when interest rates were essentially zero or even lower in developed markets, Daw said.

“When you get dollar deposits now at 2.5 to 3 percent that really changes people’s perspective on what they want to or need to invest in. You don’t necessarily need as much yield as before to possibly achieve the similar type of investment objectives,” he said.

Finally, Daw noted that not much of the inflows into emerging markets has flowed back out, even as U.S. assets are offering some competition on yield.

“If U.S. rates are where they are or a bit higher and growth is slowing, what’s going to be the catalyst for investors to deploy more money into emerging markets when they already have quite a bit as far as their overall stock of assets,” he asked.

That forecast for a gloomy year for emerging markets wasn’t necessarily set in stone, with Daw pointing to three factors that could change the outlook: Firstly, Chinese economic growth could be bolstered if policy makers turn to more aggressive stimulus measures. Secondly, a resolution to the U.S. trade war would improve the emerging market growth outlook, he said.

And finally, the U.S. Federal Reserve could pause in its rate-hiking cycle, he said, but added that for it to be positive for emerging markets, it would need to be because policy makers deemed inflation wasn’t problematic and not because they were worried about economic growth or because of financial market stress.

But Daw said was skeptical those would occur.

“We think there are downside risks to our forecasts, rather than upside ones,” he said.

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