I’ve just returned from several days in Washington at the Spring Meetings of the IMF and World Bank, where I spoke to a range of investors, policymakers and academics. Overall, the mood was subdued, colored by continued concerns on growth, trade risks and other sources of policy uncertainty including central bank independence. While most thought growth was ok, there continue to be concerns about preparation for the next crisis. The officials, especially those from Europe remained more pessimistic than most investors, who see some of the same sluggish growth as perpetuating low rates and expecting some move into EM assets.
- Among EM, Turkey remains a major trouble spot, and to a lesser extent Argentina and some frontier African economies, while Russia was seen was seen as a bright spot (at least tactically),and select Latam and ASEAN credits neutral.
- Venezuela was a frequent topic of conversation, as officials searched for new policies to break deadlock and prepared for an eventual request. Guaido proxies were present at sideline meetings articulating a “market-friendly” message that may be hard to deliver on. We continue to believe that investors may still be too optimistic on long-term recovery value or rather on needed costs.
- Frontier market debt burdens triggered a lot of concens (and many many sideline events). While aggregate worrries seem misplaced there are significant pockets of concern, and efforts to improve data seem to be moving forward.
- European officials seemed downbeat, some raising concerns about Japanification – low growth and limited price pressure. The Brextension brought some relief to those worried about a crash-out, but provides little clarity to help investment.
- US policy was a big focus, with central bank independence outstripping trade policy as a source of concern. Many investors sought clarity on the legislative priorities including USMCA, sanctions, domestic initiatives and of course their role in the IFIs. US officials regularly emphasized their hope that IFIs would do more to support poorest countries and less in the richer and larger EMs (China, but also some of the other BRICS). This coincides with a contemporaneous effort to reduce some of the separate but different treatment at the WTO and is thus a theme to watch.
Growth OK, and Recession risks in abeyance
The IMF again downgraded its growth forecasts for most major economies, converging down to consensus. Despite noting downside risks, they point to an reacceleration in 2020, though LT growth trends remain weaker than what they were forecasting a few years ago. Some areas of major debate remains around the nature and dynamics of growth in China, U.S, and some EM. Few mentioned the risks of a negative draft from oil concerns. The key question whether the slowdown is idiosyncratic (slowdown in China, recession in Turkey, belated attempt at CB exiting) or whether those will recur.
There wasn’t yet much discussion about whether rising oil prices would dampen growth, perhaps because the OPEC basket average is just about $70/barrel. With key deadlines on the Iran waivers, continued financial squeeze on Venezuela, policical pressures in Algeria, Libya Sudan among others, short-term price increases seem a risk. I continue to believe that US shale will likely outperform expectations again in H2 or for the year as a whole which suggests some downdraft and persistence of volatility.
Europe stands out for weakest performance as a combination of slower global trade growth, political risks (Turkey, UK, Italy) as well as tight fiscal policy are weighing on domestic demand. By contrast, while slowing, the U.S. remains one of the stronger global economies. Most forecasters expected that the recent easing of financial conditions since the start of the year (due to Fed, China Stimulus and Trade repricing) would help stabilize the outlook, leading to a modest improvement in H2. IMF forecasts suggest most countries will re-accelerate next year, suggesting the recent slowdown was idiosyncratic. That still looks somewhat optimistic in a few cases we will be talking about in upcoming posts.
Is the good news already priced in or is there room for another rally? Some asked whether so much ok news was priced in already and where are the big mispricings? U.S. equity valuations are being seen as somewhat stretched. EM local debt has underperformed in the rally this year, attracting much few inflows than hard currency. While most EM investors seemed upbeat and looked to add investment.
Turkey tops the worry list: Official meetings with investors did little to alleviate concerns about Turkish policies and may have added to them. The Turkish officials again stressed policies they are doing to shore up the fiscal position (long the solid part of its balance sheet) but said little on plans to support the banks (the real vulnerability). Given the recent boost in public bank credit and greater state role in the sector, the contingent liabilities are growing. The recession, FX depreciation and high rates have hit domestic demand, narrowing the current account deficit sharply, but bringing political costs. . The combination of the painful pre-election squeeze on investors, the deadlock on recognizing election results and the tradeoffs between financial stability and growth have kicked worries into high gear. Many long-time Turkey watchers are now advocating for an IMF deal. That political hot potato currently looks unlikely with no real preliminary talks. Turkey was able to temporarily implement an even more aggressive adjustment last year than the IMF would likely have prescribed, but the costs of that are mounting. Beyond local hurdles and the political and security issues with the U.S. support to a country like Turkey would probably spark a red flag to a US administration that wants the IFIs to so less support of middle-income countries not more.
Other countries on the watchlist include South Africa, where contingent liabilities are impairing the sovereign balance sheet, leaving even less fiscal space, the country is barely growing, and inflation is stuck at the midpoint of the target. The power outages are adding to domestic production and demand vulnerabilities. While an ANC victory is likely, the question is how extensive and how the Ramaphosa government will balance the demands of the unions, factions like the EFF and others. Its likely to be hard times still ahead, especially as some institutions and infrastructure are gradually eroding.
India too is in focus ahead of elections. Growth remains decent but liquidity and credit impulse is low and fiscal constraints add to limited policy space. Much of this reflects the low or non-performing bank assets remain a drag on future growth and investments. Despite continued issues in doing business, funding from SWF and other LT investors continues to be a relative bright spot. The election, which starts this week will bring a few key signposts – what policies would follow in either a Modi mark 2 or a Congress government? What if neither party might have a meaningful mandate. India also faces a US bilateral relationship that is less supportive – as well as concerns on elements of trade also from the EU. Looking ahead, they are likely to balance their risks around energy supply.
What do they like? Russia was seen as a top pick especially as sanctions risks are thought to be receding – more on that in a later piece, as well as some other oil producers and select ASEAN countries. Russia’s fiscal and external balance sheets are strong, despite some hoped for stimulus this year. Russia stands out as one of the most by-the-book monetary policy and conservative fiscal stance. All of these are part of Russia’s resiliency toolkit
Somewhere in between lie Latam countries which benefit from higher real rates. Brazil. Consensus seems to expect that Brazil is likely to pass the pension reform, which is key to MT fiscal consolidation, though Bolsonaro still lacks sufficient (2/3) support in the lower house. Locals remain more optimistic than foreigners and the good news may already be priced suggesting that set backs may provide entry points.
Trade: China Deal expected Sometime, Worry Shifts to Europe and Stalled USMCA
Most people we spoke to expected the U.S. and China would reach a deal, though the terms of that deal and enforcement remain in question. Few thought that it will hold more than a year though, but the managed trade elements (including commodity purchases) and some concessions should help on the campaign trail and help alleviate the risk of a renewed escalation. Still, trade deals aren’t done till they are done, and it could take some time before this part of the trade roller coaster crests.
Two other trade issues generated more concern – the risks that USMCA will not be ratified and the revival of never-far-dormant U.S. pressure on Europe (especially Germany). The congressional process was always going to be difficult, especially with the Democratic House, but the political environment is deteriorating especially as the presidential race picks up. Failure to ratify is still not my baseline, but something to watch. Note that the administration has not yet sent the final bill to Congress. At this point, new tariffs seem unlikely, but this risk could complicate an already difficult election in Canada.
EU officials hoped to kick the can on Trade discussions until the new commission came into office towards the end of the year (as many also hoped on Brexit, which also received an extension). Retaliation for the airbus case, and lingering risks of auto tariffs threaten to add to divides within Europe
Some official sector folks seemed to hope there might be a change in government and to be putting off decisions until 2021. That doesn’t seem to be a wise decision a) because it underestimates the role of congress and divides within the US political system b) underestimates some of the areas in which there are changes that are bipartisan. More to come
Ziemba Insights 