A strong start to the year for emerging markets

22 January 2020

Galvin ChiaEmerging Markets Strategist, CEEMEA

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Olgay BuyukkayaliHead of Emerging Markets Strategy and Macro Analysis

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A Strong Start To The Year For Emerging Markets NWM

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One of NatWest Market’s key themes for 2020 is that emerging market fundamentals are set to improve. And thanks to some positive data from the recent Purchasing Managers’ Index (PMI) survey, the region has already had a strong start to the year. Here’s why.

Emerging markets (EM): Less economically developed countries, typically with average per-person incomes of between US$3,000 - $12,000, that nonetheless have sizeable financial markets. At NatWest Markets, some of the biggest emerging markets we look at include Argentina, Brazil, China, India, Indonesia, Mexico, Russia, South Africa, South Korea and Turkey
Developed markets (DM): More economically developed countries, with average per-person incomes of above US$16,000 per year, whose markets exert a sizeable influence in the financial world. These typically include Australia, Canada, the eurozone, Japan, New Zealand, Norway, Sweden, Switzerland, the UK and the US. 

Signs of emerging market recovery – albeit fragile

After a long period where economic growth was underperforming its historical track record, it looks as though we can safely say that emerging market growth is now benefitting from a better global environment. Lower interest rates have been supportive, as have easing trade-related risks. There are signs that there is some economic recovery in emerging markets – albeit a fragile one. 

Spotlight on Purchasing Managers’ Index data

Recent Purchasing Managers’ Index (PMIs) data illustrates this fundamental improvement well. The PMI index summarises the sentiment of business managers and manufacturers, and is often used as a leading indicator of where manufacturing activity is headed next. Figure 1 shows that manufacturing sentiment in emerging markets has stabilised above 50 – the threshold used to signal an expansion in economic activity. This has helped keep the global PMI above 50.

One key observation is that there are also more emerging market countries with PMIs above 50 than below, compared to developed markets. The reading for developed markets, on the whole, continues to remain pessimistically below 50 (Figure 2).

Figure 1: The global PMI is above 50 for the second month in a row, with the EM PMI stable

Source: Markit, Haver, NatWest Markets

Figure 2: The number of EM economies with PMIs above 50 is rising, while it is falling in developed market economies

Source: Markit, Haver, NatWest Markets

Asia takes the lead for improving sentiment…

Regionally, Asia is leading the improvement in sentiment. Notably, Korea and Taiwan have returned to readings above 50, after spending most of 2019 in contractionary territory (Figure 3). This is encouraging, given that Korea and Taiwan were some of the countries most exposed to US-China trade tensions. This has coincided with easing trade-war related tensions in December.

Figure 3: Regional PMIs – Asia is leading the recovery

Source: Markit, Haver, NatWest Markets

… While readings from other regions have been mixed

While the numbers have been low in the Central & Eastern Europe, Middle East, and African (CEEMEA) region, better sentiment in Russia led to an uptick for the regional number. Latin American readings were pulled down by a softer reading in Brazil and continued contractionary readings in Mexico.

But these are not always accurate signals for what the future may bring. PMI readings from CEEMEA countries, like the Czech Republic and Poland, have not necessarily been reflective of manufacturing activity, as they have been overly pessimistic compared to the economic data. Similarly, despite softer PMI numbers the economic outlook for Brazil remains optimistic, with robust credit growth and better than expected employment and economic confidence surveys.

Similarly, it may take some time before actual trade data improve. Export growth among the regions is still negative in year-on-year terms, having declined significantly late 2018 and 2019 (Figure 4). And of course the prospect for wide-ranging risks (such as a re-escalation of US-China trade tensions) cannot yet be entirely ruled out. This is why we think that the recovery so far has been fragile.

Figure 4: The recovery is fragile, and exports growth (in year-on-year terms) is still negative

Source: Markit, Haver, NatWest Markets

What does the change in the global growth dynamic mean for markets?

The cautiously optimistic signals from emerging market PMIs could have positive implications for emerging market currencies. For one, real interest rates (or interest rates adjusted for inflation) in emerging markets are falling slower than they are in developed markets. This is a result that we think will be broadly supportive for emerging market currencies.

Additionally, prior periods of recovering growth sentiment in emerging markets and globally have seen emerging market currencies benefit. This has particularly been the case when emerging market PMIs have risen above global PMIs, as episodes in 2011 and 2016 suggest.

Overall, we continue to be broadly optimistic in the outlook for emerging market assets and will keeping a close eye on the market fundamentals over the course of 2020 and beyond. 

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