The re-nomination of Jerome Powell as US Fed Chair at the end of November re-affirms the continuation of the Fed policy for a prudent normalisation, which should result in higher rates and a flatter curve amid higher inflation prints as the backdrop for investing in emerging markets going forward, says Yerlan Syzdykov, Global Head of Emerging Markets, Amundi.
The other backdrop is the prevalence of Covid-19 variants, and their likely persistence into next year. Although it is challenging to ascertain the impact from the spread of the Omicron virus on global activity and thus growth, more generally, we expect growth to decelerate in 2022 amidst China's slowdown.
In China, we believe that some of the self-imposed policy constraints - zero-tolerance Covid-19 policy, energy emission controls for high-polluting and high-emission sectors, tightening in the housing market since Q4 2020 - will be relaxed. We expect some loosening in domestic credit conditions in December and overall macro policies to turn more risk-friendly in 2022.
The recent RRR cut by the PBoC will effectively release ~RMB1.2tn of liquidity into the system. This move is a positive signal, driven by the need to encourage more lending, support growth and ensure sufficient liquidity. We expect further easing measures from here on as the Chinese authorities prioritize stability and housing sector support.
Overall, with regards to EM growth, although the premium versus Developed Markets should be lower in 2022 on average, it will continue to improve over the year and bounce back in 2023 given the continued roll-out of vaccinations and a constructive outlook for China.
We forecast EMs to grow at 4.4% in 2022, down from 6.5% in 2021. In 2022, we expect that growth momentum will favour Asia versus Latam and CEEMEA, which is quite different from the picture in 2021, as Asian economies gradually recover from their zero-tolerance Covid-19 policies.
In terms of our inflation outlook, we are beginning to see a decline in container freight and shipment rates, which should help alleviate some of the pressures on inflation. While we expect inflation to remain high in the first half of 2022, it should decline in the latter half as supply bottlenecks and disruptions adjust. Food prices, which have also added to inflationary pressures in 2021, should moderate, easing the pressure in countries where they are not subsidised by the government.
An exception to our overall inflation outlook is for Asia, where inflation was subdued in 2021 while we expect it to increase in 2022 due to pent-up demand. However, this would be more gradual compared to the rises seen in CEEMEA and Latin America in 2021. Indeed, in Asia, we think that the rise in inflation will be within central bank targets and is therefore not a concern.
On the new variant Omicron, while it is very challenging to call for its impact on global growth and subsequent actions by governments and central banks given the limited availability of data, we could estimate an impact similar to that of Delta during Q2/Q3 '21. Demand should drop in the short term, but should be built-up and released later on, leaving ~2yr forward output expectations to be relatively unaffected.
The damage to supply chains, however, should add further pressure to inflation in the short term. Therefore, we think central banks may continue to feel the pressure to tighten policy even in the face of renewed uncertainty on the Covid front.
We have seen a very credible response from EM central banks to fight inflationary pressures in 2021- Brazil, Mexico, Chile, Colombia, Peru, Poland, Czech Republic, Hungary, Russia, and South Africa have all already hiked more than what was priced at the beginning of the year. The tighter monetary policy for EMs in 2021 is likely to result in weaker growth, lower inflation, and as a result, lower rates than the market expects in 2022. In contrast, the loose monetary policy of the US in 2021 is likely to result in stronger growth, higher inflation, and as a result, higher rates compared to market expectations. This important divergence of macro dynamics should have important implications for EM assets, particularly for EM fixed income.
Starting with EM Local Currency, although this backdrop leaves us more constructive on rates, we remain cautious on EM currencies. On the other hand, we are constructive on EM Hard Currency debt given the early- to mid- cycle global dynamics, which tends to play positively for spreads.
Nevertheless, we believe a prudent approach is the way forward - overall, higher core rates and weaker EM currencies are likely to challenge total returns for EM debt more generally and thus result in modest single digit returns next year. Short duration plays should therefore benefit portfolio allocations in 2022, particularly through a tilt to high yield where the higher carry should provide a cushion against higher core rates.
It is important to bear in mind that EMs continue to remain a heterogeneous play - economic divergences in growth and inflation dynamics, central bank policy trajectories and vulnerabilities to external shocks particularly to capital flows, and finally, political volatility continues to vary widely across countries and therefore selectively remains a key source of alpha generation.
An area where we see opportunities in 2022 for instance is in oil sensitive EMs, both through sovereigns and corporates. While oil prices have been weaker recently amidst the Omicron uncertainty, which has been a headwind for global demand, the ongoing supply shortage and OPEC's management of supply in light of this, should help support prices.
Our favoured asset class for 2022 is EM equities, where prospects of the EM growth premium versus DMs bouncing back in the latter half of 2022 and cheap relative valuations should provide support. Although in the near term the Chinese slow-down could result in some volatility, China's long-term story remains intact and well supported by the leadership's goal for Common Prosperity, which promotes higher quality growth, social wellbeing and environmental sustainability.
The multi-year implementation plan will bring opportunities in the consumer sector as well as be supportive for small and mid-caps. We also remain positive on the technology sector at attractive valuations.
For investors seeking sustainable and ESG plays, China offers a plethora of investment opportunities in debt and equities, and ranging from renewable energy generation to clean transportation and energy-efficient infrastructure. Despite the uncertain short-term outlook, these opportunities will be hard to ignore.
Finally, while ESG integration in investment portfolios continues to be critical, the next generation of ESG strategies should see more tailored concepts such as ESG improvers (those companies that are not yet ESG leaders but have demonstrated a promising ESG trajectory) come to the forefront. Here the motivation is driven by the focus on engagement for enhancing returns, both from a financial and social impact perspective.
Thematic plays such green, climate transition or social/sustainable bonds should also be areas of attention, as more EMs sign up to net-zero and just transition targets.
By Yerlan Syzdykov, Global Head of Emerging Markets, Amundi.
