US dollar reverses initial weakness, presenting a currency headwind for performance.

The performance of emerging market equities was mixed over the period, despite some initial optimism around China’s efforts to boost its economy. In currency markets, a weakening US dollar in early July supported emerging market equities initially but the situation later reversed and dollar strength proved to be a familiar narrative for much of Q3. Brazilian companies benefited when the country’s central bank cut interest rates in August for the first time since 2020, followed by a second cut in September. Also of note, in August the Brazilian government announced a massive spending plan to bolster the economy, focused on infrastructure investment and designed to kickstart a green transition. Meanwhile, South Africa’s market was buoyed by a recovery in commodity prices, and the country’s economy grew more than forecast in the second quarter of 2023. Elsewhere, Turkish shares rallied significantly as the central bank again hiked interest rates to tackle rampant inflation, with investor sentiment buoyed on hopes of a return to more conventional economic policy. Finally, India’s economy grew more than expected in the second quarter of 2023 on a strong service sector performance and rising consumer demand.

Our neutral outlook for Emerging Market equities disguises a more cautious view towards the mix of emerging countries outside of our preferred Asia Pacific (excluding Japan) focus. US dollar strength which re-emerged during much of Q3 was a reminder of the challenges for dollar-denominated debt and investment flows into the region more broadly. Given the still-uncertain global economic outlook, this headwind for commodity prices might also weigh against those emerging markets which are more resource-export-led. It is notable that China, a consumer of significant shares of global commodity export markets, has appeared to prioritise a domestic, services-led, consumption recovery rather than lean on the past-model of infrastructure spend to boost its economy. This might challenge the traditional emerging market ‘playbook’ where emerging market export growth feeds off a Chinese-led global commodity reflation narrative. Coupled with a so-called ‘near-shoring’ of global supply chains post pandemic, this has undoubtably complicated what might otherwise be a more normal economic growth profile that emerging economies might hope for.

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References

Source: https://www.brooksmacdonald.com/insights/qmo-q3-2023-emerging-markets