Stagflation sends traders to emerging markets


Yet, it is in pockets of emerging economies that antidotes to stagflation exist – faster growth, accommodative policy, and inflation-adjusted returns – that may unlock opportunities in everything from Indian equities to Brazil’s currency and Chinese bonds.

KUALA LUMPUR: For the first time in four decades, investors in the United States and other rich economies are looking for a portfolio strategy that can win against both elevated inflation and recession at the same time.

No one knows what shape such a stagflation playbook will take, but one thing seems certain – it will include some emerging-market (EM) assets.

Stocks and bonds of poorer nations have sunk this year amid US Federal Reserve (Fed) tightening and runaway consumer prices, and may sell off even more if the global economy stalls.

Yet, it is in pockets of emerging economies that antidotes to stagflation exist – faster growth, accommodative policy, and inflation-adjusted returns – that may unlock opportunities in everything from Indian equities to Brazil’s currency and Chinese bonds.

“Stagflation will force investors to look for pockets of growth in the world, and EMs will be the first in line, especially those more immune from weakening global demand,” said Trinh Nguyen, a senior economist at Natixis SA.

“Countries that have huge growing domestic markets that not only shield their economies from a global recession but also benefit from it will do particularly well.”

The probability of a recession in the US has soared to 50% for only the second time since the 2008 financial crisis.

Inflation in the world’s largest economy has shown signs of peaking but is expected to remain far above the Fed’s target of 2% at least until 2024.

In the United Kingdom and Europe, consumer prices are still rising while an energy crisis makes economic contraction likely.

That’s unfamiliar territory for a generation of traders. Since 1982, growth and inflation risks have gone hand in hand, while recessions reset economies with lower prices.

But now, consumer-price indexes and growth have decoupled, both worsening simultaneously and calling for an entirely new trading paradigm.

While stagflation in the US and Europe may hamper developing economies relying on exports, it could put nations with strong domestic consumer demand and less reliance on Western markets at an advantage.

That would benefit countries with domestically focused companies, and India stands out in this regard.

In general, nations offering some kind of relative insulation from Western economies are likely to attract investment interest.

This could take the form of lower vulnerability to imported inflation, less need for foreign capital or monetary-policy divergence.

Sue Trinh, the head of macro strategy for Asia at Manulife Investment Management, identifies Indonesia, Malaysia and Vietnam as examples.

China’s bias toward a looser monetary policy, a popular theme for global investors, may become more compelling.

Retreating factory-gate inflation, a property-sector meltdown, and a fragile recovery clouded by Covid outbursts are keeping policymakers committed to further easing.

And the People’s Bank of China did just that yesterday as it unexpectedly lowered the rate on its one-year policy loans by 10 basis points to 2.75%, the first reduction of a key rate since January.

Brazil is an oasis in Latin America, where the overall mood is one of gloom over persistent inflation and growth constriction brought on by policy tightening.

The nation’s consumer-price growth fell in July, responding to one of the most aggressive hiking cycles in EMs.

That left Brazil with a real yield of 3.68 percentage points. — Bloomberg

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