Emerging Markets Face Next Quarter With 2023 Bets in Ruins

Emerging markets ended a volatile quarter with China’s plunging economy, spiking US yields and rising oil prices sparking the worst decline in stocks in a year.

(Bloomberg) — Emerging markets ended a volatile quarter with China’s plunging economy, spiking US yields and rising oil prices sparking the worst decline in stocks in a year.

Despite a rebound on Friday, stocks saw a $470 billion wipe-out, currencies posted back-to-back quarterly losses and sovereign-risk premiums hovered at a three-month high. It’s now clear that expectations at the start of the year for a rally in Chinese markets and outperformance by emerging markets over developed markets have not panned out.

What is less clear is what the last stretch of 2023 holds, as investors assess whether the worst of bad news in those key themes is over. China’s economy is stabilizing, Brent crude prices may be peaking and a resurgent dollar stalled after reaching a 10-month high. What’s more, weak US consumer spending data and a slower-than-expected increase in Fed’s preferred measure of inflation have spurred hopes that US rate hikes may halt. 

“The EM rates and EMFX carry trade has been derailed by the relentless move up in US rates,” Citigroup Inc. strategists including Dirk Willer wrote in a note to clients. “With US rates trading as if they still are in a bear market, we are cautious in the short term until we see signs of US weakness.”

Read More: Goldman, HSBC Grow Cautious on One of Year’s Hottest EM Trades

MSCI’s stock index rose 0.8% on Friday as Chinese technology stocks came back in favor. That trimmed quarterly losses to 3.7%, its worst performance in a year. The currency gauge also ticked up on the last trading session of September, with Chile’s peso, Hungary’s forint and Thai baht leading gains. It ended the quarter 0.4% lower, a second straight decline.

Mexico’s peso was supported by a hawkish tone when policymakers held interest rates steady on Thursday, feeding expectations that the country may be the last in the region to lower borrowing costs. Colombia’s central bank also held interest rates at a quarter-century high on Friday, though economists are expecting a cut next month. 

Fourth-Quarter Themes

In China, where stocks have erased $1.7 trillion of shareholder wealth since early February, satellite data show an economic rebound is at last taking hold. Recent releases showing an improvement in industrial profits have boosted bets for the start of a new earnings cycle.

US labor-market trends will play a key role in the Fed’s calculation of a peak rate. Resilience in employment data in the face of successive rate hikes has been one of the surprises of the year and kept inflation expectations buoyed. While Fed policymakers let the target range for their benchmark rate unchanged, fresh quarterly projections showed 12 of the 19 officials favored another hike in 2023. 

Moves in US yields and the dollar will track developments in these two themes. Any strength in them could filter through to emerging markets as another selloff. Though investors will hope the recent signs of exhaustion in the US asset rallies continue, sparking a fourth-quarter rebound.     

–With assistance from Michael O’Boyle.

(Updates moves throughout)

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