The Bank of Japan’s rate hike at the end of July, coupled with hawkish rhetoric, triggered a bout of market jitters, sending shares sharply lower and causing an unwind of yen funded trades. This was followed by a U.S. growth scare, as disappointing employment figures challenged the prevailing narrative of a gradual deceleration. Global shares sank and volatility spiked further. Investors’ assessment of the Federal Reserve’s (the “Fed) easing cycle, moreover, shifted to price in a more aggressive rate cut path. By mid-August, however, global stocks reversed most loses – coming within 1% of their mid-July all-time highs. This recovery was driven by Japanese policymakers softening their hawkish guidance and better-than-expected U.S. data, which reassured investors that a hard landing was not imminent. In the latest Global Strategy Meeting (“GSM”), analysts and portfolio managers reviewed emerging market (“EM”) assets in the context of recent global skittishness and discussed the potential implications for future performance.
The return of the growth-centric market
The discussion began by highlighting the magnitude and speed of the recent correction and subsequent rebound across various asset classes, and how investors seemed to be reacting to every growth data point. And such “data-point driven” markets tend to be more volatile as narratives become unstable, evidenced by the sudden swing from soft landing conviction to recessionary fears seen in the first few days of August.
A month ago, in July’s GSM, participants were already noting signs of shifts in cross-asset correlations, suggesting investors’ focus was moving towards growth (TRG’s Macro Conversation: July 2024). A string of benign inflation readings reinforced expectations of further disinflation and the start of the long-awaited easing cycle in the U.S. later this year. In fact, global stocks peaked in mid-July, coinciding with markets pricing in a 100% probability of a quarter-point cut in September. With Fed easing seemingly no longer in question, investors gradually shifted their attention to growth. One portfolio manager highlighted that optimism about prospects for lower interest rates allowed the market to ignore mixed growth figures, particularly in the U.S. where economic data surprises have been negative since May. Over the past month, the rapid turn in stock-bond correlations signaled a decisive move to a growth-driven dynamic or, as a speaker put it, back to a “bad economic news means bad market news” regime (see Figure 1).
On the debate about the path for the U.S. economy, there was broad consensus that recession fears were overblown; still, speakers thought that the intense scrutiny of every data point will continue as investors seek greater confidence that downside growth risks are subsiding. Without any offsets from Europe and China – both of which remain sluggish and where outlooks are challenged – some thought prospects for the U.S. economy will keep setting the tone for global markets. Others noted that Fed easing is supportive of risk and that stocks, in both emerging and industrialized markets, tend to move higher when rate cuts start, provided a recession does not follow.
August of uncertainty: EM implications
The second part of the GSM turned to the implications for EM from the recent market jitters. While the turbulence was short lived, it is encouraging that nothing “broke” in EM as a result. The episode didn’t expose financial fragilities and markets adjusted in an orderly fashion, even those that experienced outsized moves from the unwind of yen funded trades. Predictably, EM shares sold-off in solidarity with Japan and U.S. concerns; the encouraging part is that EM kept up on the way up, also approaching the mid-July highs for the year (see Figure 2).
One speaker argued that the unwind of yen-funded trades and recent market gyrations may refocus investors on fundamentals and idiosyncratic drivers of alpha. Momentum has been the best performing factor in 2024 for global stocks, a strategy that came under pressure during the correction. Concerns over U.S. and global growth partly contributed to a rotation from cyclicals to defensive sectors, too. And there has been plenty of dispersion, for example, between stronger and weaker credits in the EM sovereign space. Whether the growth centric regime ends up favoring EM versus developed markets is a question mark, but it may at least open room for more differentiation favoring higher quality EM assets with compelling stories that could better withstand growth hiccups.
Another noteworthy aspect of recent market action is the modest weakening of the dollar. So far, depreciation consistent with a soft-landing scenario has mostly played out against major currencies like the yen, euro, and the Swiss franc, as well as oversold EM Asia which follow yen moves more closely. In fact, we’ve argued that a re-anchoring of the yen was a necessary precondition for assets in emerging Asia to outperform (TRG Macro Mosaic: Anatomy of a Global Sell-off). Stronger Asian currencies should also allow central banks to cut rates and better calibrate policy stances based on domestic conditions. Broad dollar weakness versus EM has not happened yet, as gains in Asia have been partly offset by the unwinding of high-yielding carry positions, mainly in Latin America. For that to occur, an acceleration in EM inflows would have to take place, something that would be consistent with a consolidation of the soft-landing story and a reduction in the election-related risk of tariffs and other trade barriers in the U.S. Recent market action is suggesting that the fine tuning of the easing cycle – whether the Fed starts with a September quarter or half-point cut – is unlikely to impact the soft-landing scenario, beyond generating some short-term volatility.
Disclaimer:
The information provided herein is for educational and informational purposes only, and neither The Rohatyn Group nor any of its affiliates (together, “TRG”) is offering any product or service hereby. The information provided herein is not a recommendation, offer, or solicitation of an offer to buy or sell any security, commodity, or derivative, nor is it a recommendation to adopt any investment strategy or otherwise to be construed as investment advice. Any projections, market outlooks, investment outlooks or estimates included herein are forward-looking statements, are based upon certain assumptions, and should not be construed as an indication that certain circumstances or events will actually occur. Other circumstances or events that were not anticipated or considered may occur and may lead to materially different outcomes. The information provided herein should not be used as the basis for making any investment decision.
Unless otherwise noted, the views expressed in the content herein reflect those of the participants in the GSM as of the date published and are not necessarily the views of TRG. In fact the views of TRG (and other asset managers) may diverge significantly from certain of the views expressed in the content herein. The views expressed in the content herein are subject to change without notice, and TRG disclaims any responsibility to furnish updated information in the event of any such change in views. Certain information contained herein has been obtained from third-party sources. While TRG deems such sources to be reliable, TRG cannot and does not warrant the information to be accurate, complete or timely, and TRG disclaims any responsibility for any loss or damage arising from reliance upon such third-party information or any other content provided herein.
Exposure to emerging markets generally entails greater risks and higher volatility than exposure to well-developed markets, including significant legal, economic and political risks. The prices of emerging market exchange rates, securities and other assets are often highly volatile and movements in such prices are influenced by, among other things, interest rates, changing market supply and demand, external market forces (particularly in relation to major trading partners), trade, fiscal and monetary programs, policies of governments and international political and economic events and policies. All investments entail risks, including possible loss of principal. Past performance is not necessarily indicative of future performance.
The information provided herein is neither tax nor legal advice. You must consult with your own tax and legal advisors regarding your particular circumstances.
