As the US-China trade war rages on, investors must not lose sight of central banks and economic fundamentals
Hannah Anderson says news about interest rates and economic growth seems to get lost in the rapidly moving news cycle but when it comes to emerging markets, central banks are the players to watch
Markets are fickle by nature – what captures investor attention one day doesn’t even make the top 10 list of most-important items to watch the next. These short attention spans can make it tough to figure out what precisely is behind any day’s moves. It also makes it difficult to tell how a shift in the fundamentals will affect markets beyond investors’ reactions to the initial news – by the time a change in fundamentals actually alters market conditions, attentions have moved on.
I experienced a bit of whiplash trying to understand what was driving emerging markets over the past week. Fundamentally, interest rates and growth outlooks have shifted a great deal in recent months. But headlines were overtaken by news about trade and investors seem to have forgotten about everything they were paying attention to previously.
On the one hand, the latest developments in the US-China trade war do merit attention. Slowing global trade, a potential result of the US-imposed higher tariffs, is a negative for emerging markets. Increasingly, emerging markets find themselves trading in line with expectations for China’s economic cycle and so any slowing growth in China due to a more challenging export environment will be felt more broadly too.
On the other hand, markets have been rightly focused on central banks’ efforts to shore up confidence in local assets for much of the summer. In an environment of rising worries about external vulnerabilities in emerging markets, investors should have expected a good deal of central bank activity.
Additionally, gradual tightening of global liquidity raises questions about the response of emerging market assets, particularly since the overwhelmingly negative reaction of emerging markets to even the mere threat of higher rates during the “taper tantrum” is still fresh in investors’ minds.
Watch: The origins and impact of the US-China trade war
When dealing with these competing narratives, I find it useful to divide central banks into three broad groups that help categorise their moves and the reasons for them, and thus, what market reactions should be to any change in policy. These groups are: the worriers, the liquidity drivers and the “wait-and-see-ers”.
The “worriers” right now include the central banks of Turkey, Argentina, Russia, Brazil, Indonesia and the Philippines. These banks have all raised rates in response to global (Turkey, Argentina) or local (Russia, Philippines) pressures. Changes in the economic fundamentals or investor attitudes towards each of these markets prompted rising worries about future conditions, which the central banks responded to, either proactively or belatedly.
The “global liquidity drivers” are well known: the US Federal Reserve, the Bank of England, the European Central Bank and the Bank of Japan are all in the process of removing the extremely accommodative monetary policies they enacted in the aftermath of the global financial crisis.
These banks are at different stages of this process, from tightening policy (the Fed, Bank of England) to thinking about tightening (European Central Bank), to keeping conditions easy for now (Bank of Japan). Being the predominant providers of liquidity to the global financial system, these banks are wary of the ramifications of moving too quickly.
The “wait-and-see-ers” represent most of the rest of central banks here in Asia. We are not immune to broader challenges in emerging markets, but domestic conditions have not warranted attention-grabbing moves from central banks. The banks in this group may well move to the “worriers” group by the end of the year – overheating domestic markets or rising inflation may prompt action from Thailand’s or India’s central bank.
However, for now, banks in this group are taking the same approach to their domestic markets that I am in trying to understand emerging markets as a whole – we’re waiting to see how fundamentals reassert themselves in a too-crowded news cycle.
Fundamentals are still shifting and investors in any asset class cannot forget about central banks; we are likely to see more actions in the rest of 2018. This narrative is still relevant for emerging markets, despite the fact that other developments are likely to grab headlines in any given week.
Hannah Anderson is a global market strategist at JP Morgan Asset Management