Emerging markets reap the fruits of global trade

Emerging market (EM) growth has shown a clear improvement since global trade growth started to pick up in November.

This improvement has been reflected in better economic activity data throughout the emerging world, but also in economic surprise indices, which have been in positive territory since December and steadily rising since. Moreover, our own EM growth momentum indicator is close to a four-year high, and EM earnings growth expectations are clearly diverging from developed markets. One of the main reasons for the growth improvement in the emerging world in the past months is the pick-up in global trade growth. We are seeing a consistent picture of better demand growth in the US, Europe and China, along with improving global export volume growth and better confidence indicators in the Asian export sector. Higher commodity prices have also helped. EM export value growth is in double digits, which has had a positive impact on activity in the industrial and mining sectors. For now, the momentum of all these indicators is strong and we see little reason to expect a weakening in the short term.

EM capital flows are becoming more favourable, as evidenced by net inflows in January and February. The better capital flows, along with appreciating currencies and growing room for monetary authorities to ease policy, have in turn improved EM financial conditions. This fairly new development helps explain investors’ latest enthusiasm for EM. EM domestic demand has not been that strong because most emerging economies, with the exception of China, are in a steady deleveraging trend after a long period of excessive credit growth, which may limit the room for any widespread improvement in demand. But easier financial conditions in combination with a strong pick-up in export growth should have some positive impact on consumption and investment growth, and help domestic demand to recover in the coming months.

A risk for EM is the rising bond yields in the developed world. An acceleration in yield increases could affect EM capital flows. For now, though, the strength in global trade is helping keep EM growth momentum close to a five-year high, despite the still-modest domestic demand picture. Doubts about US reflation could also affect EM growth expectations, especially given the weakness in EM domestic demand growth. Still, the new administration’s missteps might make far-reaching protectionist measures more unlikely. Without the protectionist fears that have prevailed in the market since November, EM probably would have performed much better than it has in that period. So with every failure of the US president to get his proposals accepted and implemented, investors are likely to worry less about import taxes and other obstacles for EM exporters to sell their goods in the US.

Maarten-Jan Bakkum – Senior Strategist, Emerging Markets – NN Investment Partners