Transcript: Are emerging markets back?

This is an audio transcript of the Unhedged podcast episode: ‘Are emerging markets back?’

Katie Martin
While we’ve got you listeners, we are very excited to be nominated for a Signal award for our podcast. So if this is your favourite finance pod, check out the link in the show notes and vote for us online. 

Robert Armstrong
This year, the Signal. Next year, the Nobel. (Laughter)

Katie Martin
One asset class that normally just loves a drop in US interest rates is emerging markets.

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And we’re seeing a little bit of it again now. Lower US rates generally mean lower US bond yields, and that makes higher-yielding emerging market government bonds really stand out. Plus, the US economy is in pretty good shape and we have a load of stimulus that just landed from China. So today on the show we’re asking: is EM back? 

This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I’m Katie Martin, a markets columnist here at FT towers in London, and I’m joined again down the line from New York City by that bright young thing, Aiden Reiter. 

Aiden Reiter
Good morning. 

Katie Martin
How are you doing, Aiden? 

Aiden Reiter
I’m good. I was just home for the Jewish holidays and my mother said to me, you know, that Katie has the most lovely voice. 

Katie Martin
(Laughter) Team Aiden’s mom. I like that. So we’re Team Aiden’s mom, but we’re also Team EM, right? Like why does EM, why do emerging markets like it when the US is cutting rates? 

Aiden Reiter
Yeah. Well, the US is the standard of the world. So when you look at emerging market debt or any other government’s debt, you’re essentially looking at its yield relative to the United States. So if the US is starting to come down, that makes those emerging markets that much more special, right? They look much better in comparison because US rates are lower. Also, emerging markets tend to hike way higher, and in this cycle they’ve actually hiked faster than the US. So they had their rates come up way before the US and other large economies. 

Katie Martin
Yeah. This is the big thing about EM, right? So as soon as we kind of came through the immediate shock of Covid and supply chains started snarling up and inflation started picking up, all the kind of big, you know, western central banks effectively looked at the Fed, the Bank of England, the European Central Bank. They were like, this is just transitory. We’re going to just sit on our hands for a little bit and see how it pans out. And the emerging markets were like, nope, we’ve seen this movie before and we are not having it. So they hiked quickly and hard. 

Aiden Reiter
And hard. Yeah. So, you know, Brazil or, you know, Mexico, they had their rates above 10 per cent as opposed to, you know, in the 3 to 5 range in the EU, the US and the UK. So that makes it really appealing if you wanna put your money there. But, you know, everybody loves the dollar. So when US rates are high, even if they’re not as high as emerging markets, it just has the effect of sucking capital out of the emerging world. 

Katie Martin
So Aiden, let’s talk about what does emerging markets mean because it’s a bit of a, sort of, it’s a bit of a squidgy term and, you know, generally people take it to mean anything that’s not kind of cool — Europe, US, Canada, Japan, which and, you know, Australia and stuff. But it’s not a terribly useful term, actually. 

Aiden Reiter
No. As you said, it’s kind of everyone except the big economies that you just named. And because of that, it’s just like this really broad index that covers economies as disparate as Brazil and South Korea. South Korea has been, quote unquote, emerging forever. And they’re kind of an advanced economy but they’re sometimes included in some of these indices and conversations about emerging markets. So it just generally means like you are not Europe or you’re not western Europe, I should say, or the US or Canada. And at some point in the last 50 years, you are a, quote unquote, developing economy and you are not unabashedly a developed economy at this point. 

Katie Martin
Listeners, you’re gonna have to bear with us here. There is just a bit of a kind of . . . There are grey areas all over this definition, but we’re talking about economies that are not like major developed economies, G7 economies, G10. So I pulled some numbers actually before I came to record this. And so the MSCI Emerging Markets index of stocks is up about 14, 15 per cent in the past five years, right? That’s not terrible. But you compare that to the MSCI World Index and there you’re looking at about 70 per cent. 

Aiden Reiter
Yeah. Yeah. Emerging markets can’t keep up. 

Katie Martin
Emerging markets can’t keep up. And you compare it to the S&P in the States and that’s . . . you’ve doubled your money on that thing over the same period. So it’s just kind of not worth the faff, like doing the due diligence on emerging markets when you could just park your money in US stocks and, you know, count it all rolling in. 

Aiden Reiter
Yeah. Which is a real shame, especially because, you know, emerging markets are ideally where there is the most room to grow and where the most amount of people could benefit from companies or stocks doing well. 

On top of that, on the government debt side, emerging markets not getting, you know, bond buyers is really, really catastrophic. We’ve had a lot of sovereign debt defaults over the last 20 years and that essentially freezes up financing in an economy and punishes the poorest people in the world, usually. So it’s just really, really unfortunate. And that’s something that has been really concerning in the past five years. And it seems like we’re starting to come out of the woods. 

Katie Martin
Well, one — not a counterpoint to that — but one interesting wrinkle to that, I think, is that, and actually our colleague Robin Wigglesworth was writing about this the other day. One of the things that’s happened in emerging market government debt over the past couple of decades, actually, is that they’ve shifted out of issuing bonds in dollars and much more into issuing bonds in their own home currency. And that makes a difference, right, because in the event that they’ve issued debt in dollars and they have to pay it back in dollars, if their currencies crash because the dollar is really strong, because US interest rates are really high, that effectively jacks up the cost of servicing their debt over the course of the lifetime of that bond. So to the extent that some of them have moved into a local currency, does that dull the effect maybe of the shifts in US policy here? 

Aiden Reiter
Yes, to an extent. But at the end of the day, you still have to look at the yield, you know, especially if it’s government-issue debt, and you have to look at the yield relative to how yields are doing in the US. So if yields are still better in the US, then you have better bang for your buck in the US. People still put their money there and have more trust there. Also, a lot of emerging markets have rule-of-law issues, as well as corruption issues that make them less appealing to some investors. 

That being said, local currency debt is probably set to do well in the next coming months. The US and the developed world affects all emerging markets. So if the US economy is achieving its soft landing and interest rates are going down, that means that there’s going to be appreciation of local currencies. That gives these companies who have issued this debt more power to service other debts. It also results in those local currency bonds looking more appealing. So it’s actually a pretty good moment to be in local currency debt on top of the structural elements of trying to insulate from dollar fluctuation. 

Katie Martin
Now, one thing I’ve noticed, Aiden, is that the world is quite big, quite large. And that means that there’s quite a lot of difference from one emerging market country to the next, right? It’s like we’re really bad people if we’re talking about as just one bloc. And we get that and we’re very conscious that we’re doing it. But you need a certain sort of shorthand to talk about the asset class. 

But there’s some real kind of outliers and like weird things going on across the world. So on the same day that the Federal Reserve in the US cut interest rates by half a percentage point, all very exciting, Brazil raised interest rates for the first time in two years. Like what the flip going on there? 

Aiden Reiter
Yeah, it just seems like their economy is really hot and inflation’s, you know, staging a bit of a comeback. So they’re gonna have to raise rates. Everything’s been fluctuating not as you would expect it relative to the US because they raised rates while the US was lowering rates. You know, I think it speaks to the point of, you know, there is a large world, as you said, and other economies function differently and have different internal pressures. Not everybody is kind of the tail that’s wagged by the US’s dog. 

Katie Martin
You could wonder which ones the tail and which is the dog here because, you know, maybe Brazil is like a tale of things to come for the US that, you know, if you have like a decent labour market and you’ve got a robust economy, then you’re not actually in a position to cut interest rates as hard as you might like to. The US is their kind of supertanker here, but sometimes it is worth looking at other smaller central banks to figure out is this a situation the US is gonna find itself in pretty soon? Because, you know, we don’t wanna go off on too much of this tangent. But already US markets are saying, a bit worried that the Fed might have cut a little bit too hard here and maybe inflation’s gonna make a comeback. Perhaps the Brazilian example is something to look at, right? 

Aiden Reiter
Absolutely. If past is prologue, Brazil started hiking rates way before the Fed and way before other, you know, global north central banks. So yeah, there’s a precedent in the past couple of years of them being ahead of the curve. 

Also, you know, when we talk about exceptions, we have to talk about China, right? China forever was considered to be an emerging market. Now, not so much. So when you look at MSCI, there’s really two broad indicators of emerging market equities, which is MSCI Emerging Markets and MSCI ex China, because China is just such a large part of MSCI World. Although interestingly, recently the China stock rally, MSCI with China shot up again and shot up above MSCI without China. 

Katie Martin
Now, this rally that we’ve had in China, since you mention it, like we spoke about this the other week. Listeners, if you look back a little bit in your list of pods that we’ve done, you’ll find we had a good chat about China. But the markets responded really kind of favourably to this, right? Just an enormous rally in Chinese stocks. It hit a bit of a wall, but nonetheless, you cannot argue with the size of that rally. 

And partly as a result of that, there’s been a huge inflow into emerging market funds. So if you look at the numbers that come out from EPFR, they so they’re getting the longest inflow streak into EM bond funds since the first half of last year and an especially big push into Chinese equity funds, which has just helped to lift the whole EM investment fund space up to a new level. So it certainly looks like investors are sort of sitting up and taking notice here. 

Aiden Reiter
Absolutely. But, you know, as we’ve said last time, without proper stimulus of the economy, that might not hold for Chinese equities when they’re already, you know, been sliding the past couple of days. So it could be that if there was any frenzy for EMs, including China, that might step off. 

But I do think there’s going to continue to be interest in emerging markets beyond Brazil. Brazil is definitely heterodox. There’s other economies that might have to raise rates. Nigeria has had a lot of funky things going on with their currency and their economy. 

Also, Turkey. Turkey has inflation that was catastrophically high for years and years. And recently in the past two years, they’ve adopted a very, very, you know, stringent central bank policy — I think policy rates around 50 per cent. So it doesn’t look like they’re going to be lowering anytime soon because while some parts of inflation are coming down as a result of these high rates, not all sectors of inflation are coming down. 

So while it’s good broadly for emerging markets, there are still some emerging markets that are these weird examples that don’t really follow the same rules. 

Katie Martin
Yeah. And Turkey always falls into that camp. It always does its own thing. Fascinating market, that one. 

Aiden Reiter
EMs are looking better. EM local currency debt is looking better and EM equities are looking better. But there’s still a really big chance and risk of default. So for the past four years, because of issues in Ukraine and then as well as, you know, the US rate hiking cycle, it looked like a lot of economies were going to default on their outstanding debt, which as we said before, is just catastrophic. 

We’ve actually kind of come out of that. The IMF have been, you know, ringing the alarm bells and saying, this is bad, this is bad. We’ve come out with very few defaults, partially because some got rescued. You had, you know, Pakistan was bailed out by the IMF, as was Kenya. Maldives was bailed out by India. So we’ve managed to avoid the worst outcome. 

But just the other day, S&P Global said that the risk of default is going to be even higher going forward. And that’s because while, you know, economic conditions have improved, we still have some big structural hurdles for a lot of these economies to jump through. Also, a lot of these economies were able to avoid default by taking some less than ideal payouts and less than ideal loans. And that’s resulted in going to be harder for them to access financing in the future. 

So, for example, Kenya — Kenya got an IMF, you know, bailout, which was really helpful to stop it from defaulting. But as we’ve seen with the local turmoil and unrest, they did so by, you know, slashing budgets in a way that people weren’t super thrilled with. And on top of that, now they can’t access the market in general because they still have to deal with that large loan and that large bailout they got from IMF. So while we avoided the worst, you know, by doing so, by dancing around default, we may have just prolonged the problem and we could see more defaults going forward, especially if the economic outlook turns on the US or any other economy. 

Katie Martin
Yeah, for sure. Not super thrilled is my descriptive phrase of choice from now on around IMF programmes, which are generally considered to be pretty tough gruel.

OK, so you got lower US rates and if they stick to what they’ve previously indicated then they’re gonna head lower still. You’ve got general kind of animal spirits around a pretty robust US economy, and that’s good. You’ve still got the risk of some defaults. You still got some slightly ugly, idiosyncratic stories. And I’m led to believe that you Americans have got some sort of election coming up. Register to vote, listeners. We just don’t know how that’s gonna pan out, particularly with regards to China around all the talk about tariffs and the two candidates have got quite different stances there. 

Aiden Reiter
If Trump enacts tariffs across the board, which he said he will do, that will really hurt EMs, right, who have, you know, trading relationships with the United States. And those are countries that don’t really have a lot of margin for error and a lot of margin for change on their relationships with other economies, right? If they lose foreign inflows, especially dollar inflows, that’ll make it harder to service their debt and will make it harder for their countries. You know, they could get more business from China. But there’s also, you know, some issues between China and EMs as well. 

Also, you know, a new administration in the White House or, you know, conflict between the US and China might also result in the US taking a less active role in dealing with IMF and helping with organisations like the International Development Association, which help economies deal with their large outstanding debt loans. So, you know, this election will be incredibly consequential for emerging markets.

And, you know, we don’t wanna see more defaults because they enact a lot of pain both on the people in those economies but also on the broader global economy. It’s really not fun for everybody to get in line as creditors and deal with the various IMF and agencies and China and everybody who has to help them come to a deal on restructuring their loan. That’s a really complicated, costly process. The global community is trying to improve it, but that is a really, really slow process. 

Katie Martin
Yeah. It’s complicated, it’s costly and it’s a massive pain in the ass. So all of that having been said, what do you think on EM? Do you think this is the start of a bit of a renaissance or do you think this is all just a little bit of a flash in the pan because you have had the cut from the US? 

Aiden Reiter
Yeah. I think if you look at EMs where they are today versus where they are two years ago when everybody thought there were imminent defaults around the corner, they’re looking great and they’ve actually started to return way better and they’ve navigated these crises quite well considering, you know, all the things ahead of them. 

And also, as you said before, with US interest rates coming down, it only is starting to look better for them. So hopefully this is a moment that will be sustained if the international community can make sure some of the sovereign debt infrastructure and architecture is resolved in case they do default down the line and if the US economy and the global economy continues to achieve the soft landing. What do you think? 

Katie Martin
I’m in Team “This is gonna be OK” because EM has been so under-owned and so just this little waft of kind of supportive news from all these different places all at once has gotta be a good thing for the asset class. I’m prepared to be proven wrong, but I hope that I’m right because it has just been off people’s radar, like I say, for so long. Aiden, we’re gonna have to wrap it up there but I have exciting news. 

Aiden Reiter
Oh. Do tell. 

Katie Martin
Unhedged, listeners, is going on the road. We are gonna be recording a live version of the show with an audience at the Kilkenomics Festival in Ireland on November the 9th. It’s free, but it’s sold out and I am, as a result, terrified. But we’d absolutely love to see you there. And if you’re heading to the festival, which is a good laugh, and you should head to the Kilkenomics Festival, it might be worth seeing if there are any spaces that come free at the back on the day. 

So yeah, listen up to see what I manage to come up with and it should be fun.

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So we’re gonna be back in a minute with Long/Short.

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Okiedokie, it’s time for Long/Short, that part of the show where we go long a thing we love or short a thing we hate. Aiden, what you got? 

Aiden Reiter
I’m short Netflix’s research department. There’s the show that everyone is talking about called Nobody Wants This and it’s about a Jewish man, a rabbi, dating a non-Jewish woman. And there were so many inaccuracies about Judaism in the first two episodes that I had to stop it. Just as a very quick example, they had services at the synagogue on a Friday night and at night you don’t wear the tallit, which is, you know, the ceremonial cloth. And they were all wearing them. It was like it’s literally every Jew could have told you that. Like, there are so many Jewish people in the United States who particularly work in Hollywood. You couldn’t have asked anybody some of these very simple questions? (Katie laughs) Like, I got so heated, just . . . I was like, there’s so many inaccuracies in episode one. Like, where is this going? 

Katie Martin
That sounds really annoying. And I would have been the same if there was something about like, Scousers or something. 

Aiden Reiter
What is your long or short, Katie? 

Katie Martin
I am long swagger. So there’s a whole lot of like swagger going on in the UK at the moment. So we just had this big like investment symposium. The government has been meeting with the great and the good from asset management, from industry and talking about, you know, the UK is open for business. And, you know, it always has been, but you know, nonetheless, there’s kind of this big kind of push. 

And so Poppy Gustafsson, who was formerly the CEO of Darktrace, which is a cyber security company, she’s very much part of this big initiative to get London and get the UK back on the map. And she said — and I agree with her — when you’re marketing into the US, you have to say, this is the best technology that has ever existed in the world, whereas British marketing tends to be, terribly sorry, if you have a minute can you possibly having a look. (Laughter) And I kind of agree with her. So we’re not very good at swagger in the UK so I’m gonna go long swagger. I’m gonna swagger for the rest of the week. 

Aiden Reiter
You gotta say, this is the greatest stock of all time and we’re gonna list it on the FTSE.

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Katie Martin
This is the greatest podcast ever and you should vote for it in awards and all that sort of thing. Anyway, I digress. Listeners, we’re gonna be back on Thursday with a very special episode. No spoilers. Back in your ears then, so listen up. 

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler.

FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. 

I’m Katie Martin. Thanks for listening.

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