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Only Brexit clouds EM outlook

While emerging markets have benefitted from a dovish stance from the US Federal Reserve and low yielding developed market bonds, the threat of Brexit could cast a shadow over their performance.

Jun 13, 2016 // 4:16PM

The Fed’s dovishness in raising interest rates has led to an improvement in global sentiment around EMs.

The Fed is looking unlikely to raise rates this month, and the markets are now prepared for a hike in September, which is already being priced in on some assets.

According to Jakob Christensen, Chief Analyst, Head of EM Research at Danske Bank, external balances across EMs have improved, which will help them weather a US rate hike.

Low yields offered by the debt in developed markets has also contributed to an improving outlook on EMs. According to Bloomberg, German 10-year government bonds were yielding 0.01%, whilst their Japanese counterparts are offering -0.17%; US 10-year Treasuries offer just 1.62%.

This is in comparison to yields on similar government bonds from Mexico and Brazil of 6.13% and 12.73%, respectively.

Although these two factors have provided a boost to EMs, the threat of Brexit has soured sentiment across all EMs, not just those in Europe.

“There is a lot of concern and uncertainty across in the markets at present,” stated Christensen. “Although bonds and currencies will be affected globally, European economies such as Poland, Hungary and to a certain extent Romania would be significantly affected by a Brexit as they receive large funds from the EU and remittances from relatives working in the UK.”

Despite Brexit woes, some non-European EMs have performed particularly well, and their fundamentals are noticeably improving. A recent pickup in the Chinese construction sector has improved the outlook for Latin American and Asian EMs, although African and Middle Eastern countries are still likely to struggle.

Asian countries have seen a significant improvement in their external balances, namely Thailand, which posted a current account surplus of US$3.163bn in April this year.

Brazil is also improving its external imbalances relatively quickly, and the country’s current account is at its strongest level in 7 years, reaching US$412mn in April.

“Mexico’s external balances are also looking good.” Although the country posted a deficit of US$6.991bn in Q1 2016, it has slowly been recovering from a low of US$9.546bn in January 2014.

The positive impact across EMs stems in part from the rebound in the Chinese construction sector, which has been slowly regaining momentum after dropping 5.2% in 2015. This will have a positive effect on commodity producing and exporting EMs such as Chile and Brazil.

“Overall, Latin American and Asian countries are the best performers across the EM space.”

Although they have been impacted by the general sentiment concerning China, Asian countries are less exposed to the world’s second largest economy as they are not as economically reliant on China as LatAm and African countries.

And, though export-focussed African economies can look forward to renewed construction sector growth from China, Christensen noted that certain countries on the continent, such as South Africa, do face challenges ahead. In South Africa’s case, necessary economic reforms are being held up by political infighting.

“MENA countries are also not particularly attractive as they rely heavily on oil prices, and have been slower to adjust to the oil realities than countries such as Russia,” he explained, adding that political and religious tensions had also made Turkey and North African countries unfavourable investments.

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