Market Insights and Education & Resources

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A monthly insight from James Syme and Paul Wimborne, managers of Pendal’s Global Emerging Markets Opportunities Fund

WE continued to see high inflation prints across the world in October.

Meanwhile, volatility in interest rate expectations and sell-offs in government bond markets are testing the resolve of central banks — which have mostly been sticking to the view that the current inflation spike will prove to be transitory.

In some developed markets there has been significant pressure on central banks, including those of the UK, Australia and Canada.

The governor of the Bank of England said their monetary policy committee would “have to act” if inflation in the prices of consumer goods and energy fed through to inflation expectations.

The Reserve Bank of Australia had to abandon its yield curve control policy (which had pegged 2024 government bond yields at 0.1%).

The bank had stopped supporting the policy as fears about inflation were priced into bond markets through October, with yields on the April 2024 government bond rising from 0.05% at the start of October to 0.78% at the end of the month.

Similarly, October saw the Bank of Canada catch rates and bond markets by surprise, ending its government-bond purchase program and accelerating expectations for when it might start hiking policy interest rates.

Emerging market central banks have not been immune from this shift.

Many emerging markets have variously seen inflation data that is high or above expectation, and sharp shifts in central bank policy.

Brazil

Brazil has seen an aggressive sell-off of government bonds in recent months, which intensified in October. Inflation data has been difficult with both September and October CPI printing above 10% YoY.

Inflation expectations continue to increase, with the five-year breakeven inflation rate now over 6%, despite the central bank (the BCB) sticking to its 2024 CPI target of 3%.

More fundamentally, fears of a water crisis (which would have inflationary implications for power pricing) or a relaxation of fiscal discipline ahead of the October 2022 presidential election have undermined confidence in BCB’s inflation-fighting credibility.

This has happened despite BCB hiking rates and the bond market pricing in continued aggressive policy rate increases.

Year-to-date, BCB has hiked the policy interest rate from 2% to 7.75%. But the shorter end of the yield curve has also moved higher by 3% or more, leaving the BCB much to do.

As we have discussed in previous commentary, this is very much driven by the inflationary outlook. The Brazilian real looks to us fundamentally cheap and the external financial position of Brazil remains very strong.

That does not, however, prevent the drag on economic activity and corporate earnings from a one-year real interest rate (adjusted for inflation expectations) of over 6%.

Central and Eastern Europe

Another region where, for different reasons, there has been a sharp shift in inflationary and interest rate expectations is Central and Eastern Europe.

The greatest shift has been in Poland, where an Australia-style move in the front-end of the yield curve forced the central bank to hike rates from 0.1% to 0.5% in the October meeting (when a hold had been expected) and then to hike again from 0.5% to 1.25% in the November meeting (when a much smaller hike had been expected).

The Czech central bank has also shocked markets with the speed and scale of rate hikes, with a tightening phase that began with a move from 0.25% to 0.5% in June 2021 accelerating to leave policy interest rates at 2.75% at the time of writing.

It is not clear that Russia has serious inflationary problems, but the central bank, the CBR, has a reputation as one of the most orthodox and hawkish central banks in EM and has steadily hiked ahead of expectations through the year.

But there are bright spots...

Amid this pattern of central banks potentially getting behind the inflationary expectations curve and having to then hike rates aggressively to catch up, there are bright spots.

Some emerging markets, despite seeing higher fuel prices and economic recoveries, have seen moderate increases in inflation and have even been able to leave policy interest rates on hold at levels that are overall stimulative.

This group absolutely includes India, which has seen inflation tick lower in recent months (to 4.35% in the year to September), allowing the Indian central bank to remain on hold, with policy rates at 4%.

Other markets have also been able to remain on hold, including Indonesia (on hold at 3.5% with inflation to October of just 1.7%), and South Africa (on hold at 3.5% with inflation to September of 5.0%).

US monetary policy impact

Clearly the overall direction of financial conditions in emerging markets will also be driven by the direction of US monetary policy.

The US Federal Reserve has kept short-term interest rates near zero. But bond markets are steadily pricing in interest-rate increases in 2022, with futures suggesting the most likely increase is two 0.25% increases next year.

As those have been priced in, with shorter-dated bond yields rising, the longer-dated part of the yield curve has been falling.

Interestingly, this is the opposite of what occurred during the taper tantrum in 2013, when the long end sold off in response to reduced asset purchases by the Fed.

Emerging markets respond well to higher growth and higher commodity prices — and poorly to higher US interest rates and increased volatility.

With global growth strong and the Fed still committed to easy monetary policies, emerging economies and emerging markets are well placed.

But we’ll need to see the volatility in rates and yields calm down before investors can be more confident about the asset class.


About Pendal Global Emerging Markets Opportunities Fund

James Syme and Paul Wimborne are senior portfolio managers and co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

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GLOBAL fixed income markets have been marching to a common theme lately.

Inflation data have been on an upward trend and there seems to be consensus that inflation will climb higher still.

Market pricing for rate rises from major central banks is outpacing what the policy makers themselves are saying.

Inflation will be going higher over the next couple of quarters. That theme is global since the driving forces behind the trend are global.

Supply chain disruptions coupled with higher goods demand have affected us all. As lockdowns lift and consumption normalises, there will be a handover from goods inflation to services inflation.

There is an assumption that rising wage pressures will be an equally global theme.

That is not the case. As RBA Assistant Governor Lucy Ellis pointed out this week, market fixation with labour market patterns offshore is leading to an overly optimistic outlook for wage developments in Australia.

Labour force participation rates in the US have been slow to recover since the depths of the pandemic. That same degree of sluggish return to work need not apply to Australia.

Initiatives such as JobKeeper have been instrumental in maintaining a link between employers and workers.

In the US, the fiscal response was aimed at generous unemployment benefits. So generous at first, in fact, that many workers chose to quit their jobs so they could access a better income stream.

Another difference is the health policy response in handling the pandemic.

In the US, despite attempts at various lockdown measures, Covid has unfortunately run rampant in the community. In Australia, a zero-Covid strategy until very recently has produced a far better population health outcome.

While the US vaccination rate seems to have stalled around the 60% mark, Australia’s vaccination rates continue to climb. New South Wales passed 92% this week.

For the US, this translates to slower re-entry into the labour force by workers who are still legitimately fearful of contracting the virus.

The resulting picture differs for wage pressures in Australia and the US.

Sure, both central banks are willing to let things run hotter for longer. But the heat is far more intense in the US.

Nevertheless, the market prices a matched pace of rate hikes for Australia and the US in 2022. Either the Fed will need outpace the market, or the RBA will prove the market wrong.

Higher yield prospects bring on more corporate issuance

Likely driven by the fear of rate hikes translating into higher refinancing rates next year, the pace of corporate issuance has been heavy so far this month, especially offshore.

European and US credit markets have seen higher-than-typical new issuance volumes in the past two weeks.

Despite continued inflows into both sectors, the supply deluge has been weighing on credit spreads — and hence the secondary market performance of many of these new deals.

In Australia the new issue pipeline has also been solid — about $3.5 billion of benchmark deals hit the market this week.

Issuers have ranged from utilities and banks to commercial and industrial real estate investment companies.

Contrary to the offshore credit climate, however, demand appetite remains very robust in Australia. Most deals have been able to price at the tighter end of price guidance and perform well in the secondary market.

Emerging market volatility

The higher yield environment would usually be a particular headache for emerging markets, especially accompanied by a climbing greenback and slowing China.

On the whole, emerging market hard currency sovereign debt has been resilient in the face of yield climbs so far this month, with yield-related widening in spreads broadly in line with global high yield. 

This is because most emerging market central banks have been proactive and keenly aware of inflation pressures.

They have no desires to invite an ugly currency-inflation spiral. Moreover, the global economy is still in good shape, in spite of China’s property-driven slow-down.

The key driver of volatility for emerging market sovereign risk has been the volatility in Turkey and in particular around the currency.

This volatility stems from the Turkish’s president’s unorthodox views on the relationship between inflation and interest rates — and hence the high turnover of the leadership of the Turkish central bank.

A noteworthy improvement now versus the last Lira crisis in 2018 is the composition of the country’s external debt rollover risk.

A lot of the maturing debt is held by the government or institutions that have historically exhibited high roll-over rates even in times of crisis.

Our portfolios currently have no exposure to the Turkish Lira — or any other high-beta local emerging market risk.

Our income strategies employ a tactical allocation to the USD emerging market sovereign index. Turkey is a component of that.

We expect political developments in Turkey to continue punctuating sovereign credit spreads with bouts of volatility, but current market pricing is also compensating investors for that volatility.

Our exposure remains highly liquid and our investment process tunes into left-tail risks.

These are aspects of our investment philosophy that will help us to de-risk promptly and efficiently out of emerging markets when warranted.

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Economics rather than environmentalism can explain much of the global renewables boom, says Regnan’s head of research, Alison George.

  • Pollution, consumer preferences driving shift to renewables
  • Economics are clear: renewables now cheapest in all key regions
  • Pursuit of net zero would turbo-charge this trend

THE transition to a renewable energy system is a mega-trend that will drive investment returns for decades.

Renewables are expected to account for 70 per cent of the $US530 billion spent on all new generation capacity in 2021, says the International Energy Agency.

But with almost every part of the global economy touched by the transition, picking investment opportunities can be daunting.

Successful investing in the transition is made even more difficult by noisy debate and political point-scoring about the best path to net-zero carbon emissions.

But beyond the noise, much of global shift to renewable energy can be explained by underlying forces that are with us today and offer some quite understandable and investable opportunities, says Alison George, head of research at Regnan, a global leader in sustainable investing.

“There’s a whole lot of change happening in energy systems — all from three key drivers,” says George.

“Emissions are important, but in developing countries it’s air pollutants that are key to changes happening now, with climate concerns coming up behind.”

Then there’s changing consumer preferences and technological advancement.

“The shifts that are occurring in the energy system are a combination of those three factors playing out over time.”

Focusing on these three drivers can give investors a much clearer understanding of how the transition will affect their portfolios.

“In China and India, they are much more concerned with the very real problem of air pollution, which is causing significant numbers of extra deaths right now,” says George.

“Similarly, Australia’s love of home solar panels is not just about incentives — it’s about people liking the idea of being in control of their own power, playing to a personal independence narrative.

“It’s not just a decarbonisation preference — it’s a consumer preference.

“Historically energy was a low-engagement purchase, then all these apps came along so you can see how much power you are generating and connect it all up.”

George says the advancement in technology, which will ultimately allow households to trade energy the same way they trade stocks, via an app on their phone, will further drive the interest in renewables.

'It’s not environmental, it’s economic'

Even global scale changes like the phasing out of coal-fired power stations can be explained by underlying economic drivers.

“Even without new commitments from governments, energy coal is already on the way out.

“It’s not environmental - it’s economic.

“In the US there has been a huge changeover from coal to gas that was entirely economically driven because of the shale gas revolution.

“Suddenly the US had an abundant source of cheap gas and that has led to a lot of very economically rational coal to gas switching.”

This combination of an energy transition being driven by factors other than climate change allows investors to think differently about how they play the transition.

One implication is that the policy debate and regulatory overlay is perhaps less important than traditional economics.

The International Energy Agency says renewable energy is now the cheapest way to lift energy production in all key regions.

“If you need more supply, the next megawatt will be renewable.

As the graph below shows, solar is the cheapest option in China and India. In the US and EU, it’s onshore wind.

The nuclear option

Economics also explain why nuclear is being left behind renewables, despite being low carbon, George says.

“Nuclear is expensive in relative terms, even in developing economies where input costs like labour and land are lower.”

That’s why nuclear doesn’t get much of a boost, even under the most ambitious decarbonisation scenarios.

“Renewables are already the best bet. It doesn’t matter what scenario we look at, renewable investment is a runaway car — it’s happening of its own accord.

“That is the key expectation that people should have.”

“Pursuit of net zero would only accelerate these trends, while also bringing hydrogen into the picture.

“There is a still a big gap between current policies and what is needed to achieve the net zero commitments being made by countries around the world.

“This represents a huge investment opportunity - worth a cumulative US$27 trillion by 2050 according to the IEA.

“Solar, wind and especially batteries would all be winners from increased environmental ambition, turbo charging current trends as more energy comes from electricity and renewables get a larger share of an even bigger electricity pie.  

“Electricity networks would also require substantial increased investment.”


About Alison George

Alison George is Regnan’s head of research. She has deep experience in ESG, responsible investment and active ownership. Alison oversees Regnan’s research frameworks, processes and outputs, ensuring it remains at the forefront of industry practice and meets evolving clients needs.

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The number of “impact bonds” more than doubled in 2021, but demand is still outstripping supply, says Pendal portfolio manager George Bishay in this fast podcast.

Impact bonds provide a financial return as well as a positive impact on the environment or society. The money is ringfenced and can only be used for pre-determined objectives.

In this short podcast George explains how the secondary market in impact bonds is driving performance:

An excerpt from this podcast

“If you are able to get hold of them, [impact bonds] perform very well in the secondary market because everyone wants them,” says Pendal’s George Bishay.

“They outperform vanilla bonds due to this huge demand.

“It’s a really powerful way to deploy capital. The only real negative is the concept of greenwashing – where an issuer comes to market and talks up their credentials only to fall short from an ESG perspective.

“We buy securities from an issuer that has a very good credit rating. That allows for the secondary market activity.”


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There are plenty of so-called ‘climate-aware’ companies to invest in — some 60 per cent of the ASX300 (by market cap) now have net zero commitments. But how do you judge the right ones? EDWINA MATTHEW explains

  • Not all net zero commitments are the same
  • Strategy and governance, disclosures and analysis of targets are critical, plus transition implications for workers
  • Red flags include board sceptics, indirect impact from value chains and lack of progress

Some 60 per cent of the ASX300 (by market cap) now have net-zero commitments.

That's a reflection of accelerating global progress on climate change.

Almost 90 per cent of global emissions are now covered by net-zero commitments from nations -- up from about 75 per cent before the recent COP26 climate change conference.

Financial institutions are also forming initiatives — such as the Glasgow Financial Alliance for Net Zero announced at COP26 — to accelerate the transition away from fossil fuels.

So Australian investors have plenty of opportunity to invest in "climate-aware" companies.

The question is: how do you judge which companies are best placed to deliver on their net-zero commitments?

“Investors and the public are sceptical about the credibility and veracity of many net-zero commitments,” says Edwina Matthew, Head of Responsible Investments at Pendal Group.

“Investors need to ensure the companies they invest in are walking the talk.

“That means having a clear and credible climate strategy in place that is based on delivering actual real-world decarbonisation, and not just ‘virtual’ reductions from carbon offsets and asset divestment.”

Below Edwina lists some key things to look for.

Examine a company’s net zero targets

A company needs targets that span the life of its transition plan – including intermediate (typically 2030) and long-term (2050) targets. They need to be science-based and aligned to the Paris Agreement.

Companies should also be clear in their disclosures about whether their targets are across "scope 1, 2 and 3 emissions" — and what percentage of its assets and emissions are covered by those targets.

What are Scope 1, 2 and 3 emissions? They are the three factors an organisation should consider to understand its carbon footprint.

  • Scope 1 greenhouse gas emissions come directly from sources controlled by a company
  • Scope 2 are indirect emissions associated with the purchase of electricity, steam, heat or cooling
  • Scope 3 result from assets not controlled by a company, but indirectly impacted by its value chain

Investors also need to look out for how carbon offsets are used in their net zero plan and also whether there is reasonable consideration of transition implications for their workforce and communities.

To mitigate risks of ‘green-washing’, investors need to not just look at the company’s targets but also look at the governance and incentive structures and disclosure practices.

Is there clear evidence that a company’s climate transition plan is incorporated into its corporate strategy and risk management systems?

Red flags to watch out for

There are also red flags for investors, Matthew says.

“One is having net zero implementation responsibilities sitting solely in a sustainability or ESG role rather than being incorporated into relevant executive and business line responsibilities.

Also look out for climate sceptics on boards or lobbying against change via industry associations.

“Investors should also assess whether scope 3 emissions are sufficiently considered. While it’s an iterative process that should be refined over time, there should be demonstrable evidence of progress.”

Climate transition plan  

Companies should have a climate transition plan with detailed analysis of material risks and opportunities.

There should be evidence the analysis is used to inform business decisions (including relevant capital allocation), resourcing and expertise and sometimes links to remuneration.

Investors should ask themselves if the board has sufficient skills. Is there stakeholder engagement? What is the track record of achieving previous transition strategies and targets?

Disclosures

Investors need to also pay close attention to disclosures.

Does a company produce reporting in line with the Task Force on Climate Related Financial Disclosures (TCFD)? How regular and comprehensive are they?

Does a corporate clearly outline the most material climate-related risks and opportunities for its business? How robust is the analysis that sits behind these views?

“We want to make sure their net zero plan is credible. It should be practical but adequately ambitious to align with key stakeholder expectations,” Matthew says.

“Without doubt the private sector on the whole is stepping up to the net zero call to action and this is a very important development.

“As investors, the onus is now on us to pay attention to the detail and progress of individual net zero plans.

“Through company engagements, we are working with companies to address any shortfalls and accelerate real economy decarbonisation.”


About Edwina Matthew

Edwina Matthew is Pendal’s Head of Responsible Investments. Edwina is responsible for maintaining our leadership position in the provision of sustainable and ethical investment products.

Edwina is actively involved in the implementation of the UN-supported Principles for Responsible Investment. She also represents the company in working groups with a number of industry associations and initiatives relating to responsible investment.

About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

We believe sustainability considerations ultimately drive higher and more stable investment returns over the long term.

Pendal Group has a proud heritage in responsible investing, extending back decades. Our specialist responsible investing business Regnan includes highly experienced ESG research and engagement experts and offers a growing range of investment strategies.

Some of our responsible investing strategies

Contact a Pendal key account manager here

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The outlook for major ASX-listed miners is looking positive again. But investing in resources is now more nuanced with issues such as ESG and China. Pendal’s BRENTON SAUNDERS explains

  • Outlook for miners is mixed and heavily dependent on China
  • But conditions should be right for a rebound next year
  • ESG issues come to the fore in AGM season

WITH a combined market cap of $190 billion, BHP, Fortescue and Rio Tinto are all top 15 companies and key pillars of the ASX.

They’re hard to avoid if you’re investing broadly in the ASX.

Iron ore is the major export of all three. When the price of the ore was above $US230 a tonne, the big three miners were reaping the benefits, and all three paid shareholders a special dividend this year.

But iron ore prices have dropped back to around $US100 a tonne and the share prices of the big three have underperformed in recent months.

So what's ahead?

“The landscape for resources is pretty dynamic at the moment,” says Saunders, an experienced geologist and manager of Pendal’s natural resources portfolio.

“Investing in resources is now much more nuanced and that has to do, in large part, with how the Chinese economy has evolved.

“The outlook is also dependent on how demand and supply evolves for some of the major commodity groups, particularly energy.

“To that extent, the outlook for the large cap miners is looking more positive again, in part because they have sold off as much as they have, as has their principal commodity, which is iron ore.”

Improved outlook for 2022

“I think it’s reasonable to think that in the first half of next year — and probably the second quarter — that the sector will improve again, albeit off a highly eroded base,” Saunders says.

The next few months could still be bumpy though.

Chinese demand for iron ore and steel is low and could get worse, Saunders says. But most of the negative sentiment is priced in.

“Also, this time of year is difficult for China from a pollution perspective as the country heads into winter and generates a large temperature inversion layer across the big metropoles, making pollution worse,” Saunders says.

“Typically at this time of year, there are restrictions on production. Then we move into Chinese New Year and after that there’s normally a rebound.”

But 2022 will be different with the Winter Olympic Games being held in Greater Beijing in February and the government determined to keep pollution levels down.

“The Beijing region does host a large percentage of the country’s steel production, so that will probably be depressed until the end of February,” Saunders says.

“Then as we move into spring, we could see an aggressive rebound that could be concurrent with stimulus and a lightening of some of the regulatory imposts on the property sector.


Follow The Point podcast: Actionable insights from Pendal portfolio managers

“There should also be a partial restocking of the steel value chain that’s been quite heavily denuded.”

ESG issues come to the fore in AGM season

It was an interesting AGM season for the major miners -- in large part thanks to the evolution of environmental, societal and governance (ESG) concerns, votes on remuneration and the emergence of vocal, activist investors.

Faced with volatile commodity prices, ESG challenges and plenty of activist investors, two of the big three -- BHP and Fortescue Metals -- have fronted shareholder in recent weeks. Rio’s AGM is later in the year.

One of the key benefits of Fortescue’s AGM is that it allows shareholders to learn more about what Fortescue Future Industries (FFI), the company’s green offshoot, is doing, says Saunders.

“It’s been a bit frustrating for shareholders because there isn’t a lot of transparency in FFI,” he says.

“The FFI business is evolving fast and it’s difficult to keep track of,” he says. “But at AGMs we learn more about it and this year was no exception.”

Two weeks ago, at the Fortescue meeting, chief executive Elizabeth Gaines revealed FFI had an unspent allocation of funds from last year, and the offshoot plans to spend $US600 million on clean energy projects this year.

BHP’s AGMs have demonstrated how the company has evolved and has been paying more attention to ESG issues.

“Over the last three years at its AGM, BHP has faced at least one quite controversial ESG proxy, or proposal,” Saunders says. “And over those three years they have become much more embracing of them because BHP’s ESG process in the background has evolved.

“BHP has actually approved some of these proposals, though when these issues first emerged several years ago the approach from them initially was to throw their hands up in the air and say that’s not feasible, or it’s unrealistic.

“There’s been quite a big evolution along the ESG lines specifically for BHP to become more aligned with some of the objectives of these action groups.”

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A monthly insight from James Syme and Paul Wimborne, managers of Pendal’s Global Emerging Markets Opportunities Fund

WE continued to see high inflation prints across the world in October.

Meanwhile, volatility in interest rate expectations and sell-offs in government bond markets are testing the resolve of central banks — which have mostly been sticking to the view that the current inflation spike will prove to be transitory.

In some developed markets there has been significant pressure on central banks, including those of the UK, Australia and Canada.

The governor of the Bank of England said their monetary policy committee would “have to act” if inflation in the prices of consumer goods and energy fed through to inflation expectations.

The Reserve Bank of Australia had to abandon its yield curve control policy (which had pegged 2024 government bond yields at 0.1%).

The bank had stopped supporting the policy as fears about inflation were priced into bond markets through October, with yields on the April 2024 government bond rising from 0.05% at the start of October to 0.78% at the end of the month.

Similarly, October saw the Bank of Canada catch rates and bond markets by surprise, ending its government-bond purchase program and accelerating expectations for when it might start hiking policy interest rates.

Emerging market central banks have not been immune from this shift.

Many emerging markets have variously seen inflation data that is high or above expectation, and sharp shifts in central bank policy.

Brazil

Brazil has seen an aggressive sell-off of government bonds in recent months, which intensified in October. Inflation data has been difficult with both September and October CPI printing above 10% YoY.

Inflation expectations continue to increase, with the five-year breakeven inflation rate now over 6%, despite the central bank (the BCB) sticking to its 2024 CPI target of 3%.

More fundamentally, fears of a water crisis (which would have inflationary implications for power pricing) or a relaxation of fiscal discipline ahead of the October 2022 presidential election have undermined confidence in BCB’s inflation-fighting credibility.

This has happened despite BCB hiking rates and the bond market pricing in continued aggressive policy rate increases.

Year-to-date, BCB has hiked the policy interest rate from 2% to 7.75%. But the shorter end of the yield curve has also moved higher by 3% or more, leaving the BCB much to do.

As we have discussed in previous commentary, this is very much driven by the inflationary outlook. The Brazilian real looks to us fundamentally cheap and the external financial position of Brazil remains very strong.

That does not, however, prevent the drag on economic activity and corporate earnings from a one-year real interest rate (adjusted for inflation expectations) of over 6%.

Central and Eastern Europe

Another region where, for different reasons, there has been a sharp shift in inflationary and interest rate expectations is Central and Eastern Europe.

The greatest shift has been in Poland, where an Australia-style move in the front-end of the yield curve forced the central bank to hike rates from 0.1% to 0.5% in the October meeting (when a hold had been expected) and then to hike again from 0.5% to 1.25% in the November meeting (when a much smaller hike had been expected).

The Czech central bank has also shocked markets with the speed and scale of rate hikes, with a tightening phase that began with a move from 0.25% to 0.5% in June 2021 accelerating to leave policy interest rates at 2.75% at the time of writing.

It is not clear that Russia has serious inflationary problems, but the central bank, the CBR, has a reputation as one of the most orthodox and hawkish central banks in EM and has steadily hiked ahead of expectations through the year.

But there are bright spots...

Amid this pattern of central banks potentially getting behind the inflationary expectations curve and having to then hike rates aggressively to catch up, there are bright spots.

Some emerging markets, despite seeing higher fuel prices and economic recoveries, have seen moderate increases in inflation and have even been able to leave policy interest rates on hold at levels that are overall stimulative.

This group absolutely includes India, which has seen inflation tick lower in recent months (to 4.35% in the year to September), allowing the Indian central bank to remain on hold, with policy rates at 4%.

Other markets have also been able to remain on hold, including Indonesia (on hold at 3.5% with inflation to October of just 1.7%), and South Africa (on hold at 3.5% with inflation to September of 5.0%).

US monetary policy impact

Clearly the overall direction of financial conditions in emerging markets will also be driven by the direction of US monetary policy.

The US Federal Reserve has kept short-term interest rates near zero. But bond markets are steadily pricing in interest-rate increases in 2022, with futures suggesting the most likely increase is two 0.25% increases next year.

As those have been priced in, with shorter-dated bond yields rising, the longer-dated part of the yield curve has been falling.

Interestingly, this is the opposite of what occurred during the taper tantrum in 2013, when the long end sold off in response to reduced asset purchases by the Fed.

Emerging markets respond well to higher growth and higher commodity prices — and poorly to higher US interest rates and increased volatility.

With global growth strong and the Fed still committed to easy monetary policies, emerging economies and emerging markets are well placed.

But we’ll need to see the volatility in rates and yields calm down before investors can be more confident about the asset class.


About Pendal Global Emerging Markets Opportunities Fund

James Syme and Paul Wimborne are senior portfolio managers and co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

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