Since the beginning of the year, emerging market risky assets have become more volatile. Segments like local currencies have performed poorly (YtD -6.8% as of the 21st of June), due to a strong USD that has finally emerged, along with the Federal Reserve’s pursuing its monetary policy normalization process. Flexible exchange rates are acting as a shock absorber, and they should allow economies to adjust, provided that sufficient buffers are there to prevent disorderly developments. However, the level of stress expressed in the financial markets is not comparable to that of past crisis events (based on the portfolio outflows and CDS widening) and there is still some appetite for EM assets. This reflects a combination of still appealing relative returns, together with the view of improved fundamentals within the asset class, barring any further disruptive scenario in terms of trade war and unexpected/uncontrolled monetary policy actions by the main central banks. This has been partially visible as far as Asian markets are concerned.

Indeed, current positive fundamentals and constructive macroeconomic conditions should not conceal the fact that emerging market countries are still very dependent on external demand. EM aggregate profits growth is very closely correlated with EM exports performance. Different dynamics in terms of commodity prices or the manufacturing cycle can shift the growth premium in favour of commodity or manufacturing producers, simply making a growth re-distribution.

However, that doesn’t change the relevance that external demand overall holds for EMs. Very few countries have been able in recent years to re-engineer their economic model from an economy mainly externally driven to one driven by domestic demand with proper governance shared between monetary and fiscal authorities and a virtuous and sustainable allocation between labour income and profits. China may be the only country slowly planning and succeeding in such a transition…