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Emerging Markets

Emerging Markets Monitor

Emerging Markets Monitor

September 2017

Patrick Zweifel, Chief Economist

Pictet Asset Management’s monthly selection of the key charts and data trends to watch in the emerging market space.

01

What caught our eye

Low EM inflation bodes well for nominal bonds and more risky assets

Aggregate EM inflation fell to 3.0% in July, its lowest level since the early 1970s. The slide has been mainly led by commodity exporting EMs, whose inflation dropped from 10.0% in August 2015 to 4.4% in July 20171.

Emerging inflation rate & monetary policy
EM Inflation and monetary policy
Source: Pictet Asset Management, CEIC, Datastream. EM inflation data from January 2000 to July 2017. EM policy rates from January 2000 to August 2017. * 30 headline consumer prices indices & 26 central bank benchmark rates GDP weighted.

Inflation contained in most countries

Almost 70% of emerging markets have inflation lower than six months ago, and perhaps more significantly, 78% currently have inflation below the target set by their central bank. 

Of the 5 markets with inflation above target, only 2 are meaningfully above: Turkey and Mexico (see our ‘In focus’ section for more on the latter). Accordingly, both have hiked rates to contain inflationary pressures. 

EM inflation rate & central bank inflation targets

Majority of EMs are in good shape

inflation contained in most countries
Source: Pictet Asset Management, CEIC, Datastream. Data as at 31/08/2017.

EM inflationary pressures should remain contained

Of the four main channels that can drive inflation, we expect three to remain subdued.  The fourth channel - commodity prices - is harder to predict at present and is the main risk.

Four main sources of inflation

Commodity prices the main risk

EN inflationary pressures
* Illustrated through the Phillips Curve which models the relationship between inflation and unemployment.

A closer look at the EM Phillips curve

EM unemployment is very close to its record low of 5.9%2, and tighter labour market conditions are often inflationary. However the Phillips Curve, which models the relationship between inflation and unemployment, shows that the EM curve for 2010-today is flatter than 2000-2009.

Put simply, our calculations show that the inflation response to a decline in unemployment is now more than three times lower than in 2000-2009.

EM Phillips curve

A flatter response rate...

phillips curve
Source: Pictet Asset Management, CEIC, Datastream, data to June 2017.

What does it mean for EM investors?

This environment of low and declining inflation (Regime 4 in the chart below) should bode well for EM nominal bonds.

Emerging countries where economic activity is improving should transition into Regime 1 and provide an attractive backdrop for riskier assets such as high yield and equities.

Best performing asset classes & regional positioning vs. business cycle environments
four regime indicator
Source: Pictet Asset Management, September 2017.

02

EM health check

EM activity remains solid

Our proprietary leading indicator of EM activity3 is still pointing towards a growth pace of 4.7%4 this year, despite another slight drop this month.
Aggregate EM real GDP growth per annum accelerated in Q2 for the fourth quarter in a row, its fastest pace in thee years.

EM industrial production increased in July at its fastest pace in more than four years. 
Our aggregated PMI survey for EM also increased to its highest level in more than four years, pointing to industrial production growth of 5.8%4.

EM leading indicator & GDP (left) / EM PMI & industrial production (right)
health check

Source: Pictet Asset Management, CEIC, Datastream. 
Left chart: EM leading indicator data from January 2011 to July 2017. EM GDP data from January 2011 to May 2017. * GDP-weighted average of 24 countries leading indicators. ** GDP-weighted average of 30 countries real GDP.
Right chart: EM PMI data from January 2011 to August 2017. EM industrial production data from January 2011 to July 2017.  * 24 Manufacturing PMIs GDP-weighted. ** 31 industrial production GDP-weighted.

03

In focus: Mexico

By Anjeza Kadilli, Economist
Mexico appears to have won the battle against inflation
The Soumaya Museum in Mexico City
The Soumaya Museum (on the left) in Mexico City

Inflation spiked in 2016 as a result of temporary currency depreciation. We believe it has peaked and will decelerate rapidly over the next year. This is largely due to Central Bank of Mexico reacting pre-emptively and aggressively to hike rates.

CPI inflation, policy rate and inflation target range
Mexico inflation
Source: Pictet Asset Management, CEIC, Datastream. Data to August 2017.

Mexico’s growth expected to accelerate in 2018

Despite the election of Donald Trump in 2016, Mexico’s economy has proved more resilient than expected, outpacing the US. Domestic consumption has been an important driver, helped by highly supportive labour market conditions, strong remittances from the US and recovering consumer confidence.

Growth is projected to reach 2.0% in 2017 with a slight acceleration for next year.

Mexican real GDP growth and potential, US GDP growth
mexico growth
Source: Pictet Asset Management, CEIC, Datastream. Mexican and US GDP growth data to Q2 2017; Mexican potential growth data to Q4 2017. *Mixed forecasting: non-accelerating inflation growth of output, HP filtering, working-age population.

Steady progress to improve the country’s fundamentals

Authorities have made good efforts to lower the fiscal deficit and contain public debt. For example, last year’s restructuring of Pemex, a state-owned oil company, should generate savings equivalent to 0.5% of GDP. The efforts paid off with an upgrade to a ‘stable outlook’ from Standard & Poor’s and Fitch.

As illustrated in the ‘Emerging countries reform responsiveness’ chart in our July edition, Mexico implemented 80% of OECD recommendations in 2015 and 40% in 2016 (still among the highest in EM).

Mexico’s Fiscal BAlance (% GDP)
mexico fiscal deficit
Source: Pictet Asset Management, CEIC, Datastream, data to Q2 2017.

04

Our EM Equity team's view

By David Chatterjee, Senior Investment Manager

Mexican equity market has showed resilience

Following the US election, Mexican equities fell c. 20% in a fortnight. Since then, the market has rallied by c. 35% after some of the more extreme fears regarding Trump’s impact on US-Mexico relations receded.
Bouncing back: Mexico post November 2016 US elections
EM equity view MSCI Mexico
Source: Bloomberg, data to 04/09/2017

We believe the banking sector is attractive due to low credit penetration

While watchful of political developments, on a bottom-up basis, we are overweight Mexico with a particular focus on the banking sector. Mexico stands out as having very low credit penetration compared with major EM peers.
Credit penetration in Mexico
EM equity view Mexico Credit
Source: JP Morgan, INEGI, CNVB (Mexican data includes SOFOMES owned by banks). Data to end of 2016.

05

Market watch

Key market data

As at 31/08/2017

Market data
Source: Datastream, Bloomberg, data as at 31/08/2017 and in USD. Equity indices are quoted on a net dividend reinvested basis; bond and commodity indices are quoted on a total return basis. The currency rates evolution is treated as a performance calculation based on FX rates.