David Hauner, CFA
Global EM FI/FX Strategist
MLI (UK)
Key takeaways
• Our sentiment indicators suggest tactical caution after recent exuberance, but our 2024 EM core view remains constructive.
• US rates & elections are risks, but global recovery supports EM. Next week China ’24 policies: low bar for positive surprise.
• Cut longs in EM rates but add on dips in FX & high yield. Favored currencies BRL, INR, KRW, PLN, TRY – funded in CNY and EUR.
Correction looming, but it’s an opportunity
Our sentiment indicators suggest tactical caution, but our 2024 EM core view remains constructive. Spreads have tightened sharply since our year-ahead “Global soft landing = EM takeoff”, with cross-over rather than dedicated investors driving EM assets. 2024 is shaping up as another complex year, and three “Walls of Worry” stand between EM and investors. In the end, we think investors will climb them. Recent exuberance points towards an overdue pullback, but eventually we continue to see 2024 as good for EM.
Wall #1: what if the Fed doesn’t cut?
The bull case for EM in 2024 has rested mostly on the Fed easing cycle, so any further delay of the first cut after the summer would likely generate volatility. Most popular EM rates markets already price that rates fall below neutral by next year, even while inflation is expected to be above targets. With EM rates bullishness at all-time highs, according to our latest FX & Rates Sentiment Survey, we recommend reducing risk in EM rates. If the global soft landing morphs into a recovery, FX and high yield offer better opportunities.
Wall #2: what if US elections boost the $?
Post summer the US elections are likely the big theme – which many investors see as a concern for EM. However, the starting point of USD strength for the next administration is already very high, and a broadening recovery may be underpinning EM performance in the face of potential election related volatility. A range of our BofA proprietary cyclical indicators point in such a direction: the Global Wave and the Global Industrial Momentum and Truckload Demand Indicators, among others, have lately triggered bullish signals.
Wall #3: what if China grows below the US?
Actually, China growing less than the US in USD terms is already the baseline. The IMF projects that US USD GDP will outperform China’s in 2024 for the third consecutive year. Accordingly, our Fund Manager Survey shows record investor pessimism on China’s growth prospects. Ahead of the announcement of China’s 2024 growth target and policies next week, the bar for positive surprises seems low. A bottoming-out of China would be the missing link between a soft landing in the US and a further EM rally.
Trades: cut risk in rates, stay long FX carry & high yield
Possible rates-induced volatility over the next few months would be an opportunity to add risk in EM with a view towards an early-cycle global recovery picking up into 2H. This means, however, a different mix of trades than the consensus owns. We would reduce longs in rates and investment grade sovereigns which are expensive. Rather, we would add on pullbacks in EM FX and high yield for exposure to carry and growth. EM FX markets we like include Brazil, India, Korea, Poland and Türkiye, funded in CNH and EUR.
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