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. Bottomline: 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.

  1. 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 under owned compared to the last decade.

  1. 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 upward sits estimates of emerging market growth to 4.0% in2023 (+0.3pp upward revision) from 3.9% last year. It estimates a slowdown in developed markets to 1.2% in2023 (+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.

  1. 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 22decision) 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.


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