Enough safeguards against global headwinds

Higher growth, moderate inflation will sustain investor interest in emerging markets

In the last few weeks, some of the risks emanating from the global markets, particularly from the US, are keeping investors on tenterhooks.

US import tariffs

The primary issue is the $568-billion trade deficit of the US with the world. The most contentious is the $375-billion deficit with China. US President Donald Trump believes that the US has been taken for a ride with lop-sided trade tariffs.

The action so far has been piece-meal. In January this year, he imposed tariffs and quotas on imported solar panels and washing machines. Earlier this month, he imposed tariff of 10 per cent and 25 per cent on import of aluminium and steel, respectively. While doing so, good friends like Canada, Mexico, Australia and others were exempt from the tariffs.

He also initiated tariffs on goods worth $60 billion with China to start with and could impose investment restrictions on Chinese individuals and companies. China retaliated with a reciprocal tariff of 25 per cent on imports worth just $3 billion but more could follow. The next 15-60 days are important where more concrete action may play out.

At the current juncture, the trade war is still nascent and hazy. The impact depends upon the answers to the following questions: What would be the action-reaction function of the US and other countries? Would tariffs be broad-based on Chinese imports or limited to items like high-tech goods?

Would the Chinese government help US corporates protect intellectual property in the future? Would China retaliate by selling US treasuries on a large scale, putting pressure on the yield curve? How far would Trump be successful in negotiating terms with NAFTA and non-NAFTA countries? How long, and to what extent, can he keep up the tariffs, as inflation could rise, impacting growth?

The US is also targeting India due to trade deficit of $22-25 billion by involving the WTO dispute settlement committee over some of the export promotion schemes that the latter offers.

As the US is a powerful member of the WTO, India has to present the case strongly with historical evidences where other countries have been allowed to incentivise exports. India would also have to deal with possible dumping by other countries looking for new markets (due to restrictions by the US). The markets expect the trade war to be moderate enough so as to satisfy the political constituents (in the US) and not impacting the macro much.

Fed rate hikes

The second issue is the pace of rate hikes in the US. As the average hourly earnings for the month of January 2018 came in at 30 basis points (bps) above expectation, a case for tightness in the labour market was made, paving the way for increased pace of rate hikes.

Also, the new Federal Reserve Chairman Jeremy Powell, in his inaugural Congressional testimony, stated that there was strong growth in the global and US economy, strength in the labour market and confidence that inflation is moving towards the target. This makes the market believe that the trajectory of rate hikes could be faster. The bond yields (10-year US treasury) are up 45 bps year-to-date (YTD) and equity markets corrected 10 per cent (S&P 500 Index) before rebounding. The data on growth, inflation and labour market has to be tracked to analyse the tipping point where the interest rates start hurting growth.

The third issue is that the repatriation of funds by US corporates has put a strain on LIBOR (London Interbank Offered Rate). Three-month LIBOR has gone up 50bps YTD to 2.2 per cent. This would put strain on financial institutions that are dependent on wholesale funding.

The fourth issue is that the liquidity pumped in by central banks is reducing by the month. The European Central Bank is committed to an asset purchase of €30 billion on a monthly basis only until September 2018, halving the number since January 2018. The Bank of Japan has been pursuing “stealth tapering” of its bond purchases.

There are enough safeguards against the above mentioned headwinds. Both IMF and World Bank have revised global growth projections for 2018 upwards by 20 bps. The earnings estimates across developed and emerging markets have been strong. The rebalancing of money moving from debt to equity is still on — $43 billion moved into global equity funds while $36 billion moved out of global money market funds in one week (week ended March 16, 2018) in the midst of the recent volatility.

Time to catch up

The dollar has been weak in spite of increased expectations of a Fed rate hike, repatriation of funds and increased volatility in the world. The Emerging Market (EM) equities have under-performed the developed markets by 60 per cent in the past seven years and their currencies have fallen 35 per cent against the dollar. Now is the time to catch up. With higher growth, moderate inflation, stable commodity prices and weak dollar, emerging markets will see continued interest from investors.

India will also be a beneficiary of the EM trade. With a 10 per cent correction in the large-cap index (individual stocks correcting more) and earnings growth picking up, Indian stocks present a compelling case for buying at these levels.

The writer is Co-CIO, Aditya Birla Sun Life Asset Manangement Company

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