We are two months into the year and market sentiment has improved as investors dissect inflation numbers, economic data, and the path of the Federal Reserve. Levels in both the Cboe Volatility Index and ICE BofAML MOVE index – respectively used to gauge volatility in stocks and U.S. Treasurys – have declined from the most recent highs seen in October 2022.

TRG’s macro analysts and portfolio managers in public markets revisited and debated four themes driving stocks, bonds and currencies. Bottom line: we contend the outlook for growth is more positive in emerging markets, but portfolios are not reflective of that because of the asset class’s past underperformance over the last decade.

1. Inflation
The debate yielded a stronger consensus among
portfolio managers and analysts about the ongoing
disinflationary trend. The factors we previously
highlighted behind the easing in goods’ price
pressures keep playing out: food and energy prices
are near lows unseen in a year or more, supply
chains are normalizing, shipping costs are falling, and
spending has shifted in favor of services. Outside
the U.S., a weaker dollar has helped stem inflation.
While questions remain about service costs, incoming
data suggests the determinants of core inflation are
improving. The more obvious sign comes from an
inflection lower in wage pressures, particularly in spots
with historically tight labor markets, including the U.S.

2. Positioning
Inflows into emerging market debt and equities
accelerated in recent weeks, reversing course from
last year. Equity inflows in January alone more than
offset outflows for the entirety of 2022. According
to JPMorgan research, more than $8 billion worth of
inflows have poured into emerging market bonds,
and approximately $27 billion into equities. Even
after the strong inflows of late, our investment team
believes there is scope for further rebalancing towards
emerging markets as the asset class remains underowned
compared to the last decade.

3. Growth
The International Monetary Fund upgraded its global
outlook at the end of January, and the numbers reveal
the growth balance is tilting in favor of emerging
markets. The IMF now projects the global economy
will grow 2.9% this year, up from its October projection
of 2.7%. Splitting the projections between emerging
and developed markets, the IMF revised upwards
its estimates of emerging market growth to 4.0% in
2023 (+0.3pp upward revision) from 3.9% last year. It
estimates a slowdown in developed markets to 1.2% in
2023 (+0.1pp revision) from 2.7% in 2022. Furthermore,
encouraging mobility data from the Lunar New Year
holiday in China – the brighter growth spot in emerging
markets – indicates a rapid normalization in activity is
on track.

“The world has been evolving, and we expect more balanced growth between developed and emerging market countries.”

4. Monetary Policy
The prospects of dollar depreciation are supportive of risky assets –
and a weaker dollar is ultimately linked to the Federal Reserve’s
policy path. There is internal consensus that the Fed’s tightening cycle
is approaching its end, and TRG participants broadly agree with the
market’s pricing of one additional quarter-point interest rate increase.
As future policy decisions become increasingly data dependent,
TRG participants argue temporary setbacks to the ongoing rally are
likely on the horizon – though they believe the larger picture
for emerging markets remains intact. Any disappointing inflation
or employment figures (there are two of each before the Fed’s next March 22 decision)
will likely spur volatility. Looking further ahead, our research team
reiterated their conviction in higher U.S. neutral rates that will settle
around 2.75-3.0%.

The U.S. dollar is one variable playing an important role in the outperformance of emerging markets – and the rest of the world. Our portfolio managers and strategists all agreed the dollar has room to weaken further, reflecting shifts in relative monetary policy stances, lack of valuation support for the dollar, and limited safe-haven bids on the perception of diminished geopolitical risks. Dalibor Eterovic, TRG’s economist in fixed income and currencies, recently wrote a piece entitled, “The U.S Dollar Has Turned. Now What?” in which he analyzes U.S. dollar cycles in the past and which macroeconomic determinants could propel a multi-year weakening trend.

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Rohatyn Group Global Markets Macro Monthly

About TRG

Founded in 2002, The Rohatyn Group specializes in emerging markets and real assets. The New York based firm currently employs over 120 professionals based in 16 cities across the U.S., Latin America, Europe, the Middle East, India, Southeast Asia and Oceania. It currently has approximately $6 billion in assets under management. For more information, please visit www.rohatyngroup.com

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