Stephen Rudman: Good day. Today is Tuesday, May 2nd, 2023. Welcome. Thank you for watching Ashmore's 'EM in 10'. My name is Stephen Rudman. I'm a member of the Ashmore New York Client Team. Today I'll be asking Gustavo Medeiros, Ashmore's Global Head of Research, to share his thoughts on the latest EM and global markets.

As always, Gustavo, welcome. We appreciate your time. Let's get started. Over the last few weeks, are there any particular moves in the markets that you feel are worth highlighting, that may have some meaning as we move forward?

Gustavo Medeiros: It might be a theme that we touched on some other 'EM in 10s', but I think the most striking element in terms of global macro data is how the manufacturing cycle remains disconnected from the service cycle.

So, last week we had leading indicators including the ISM Manufacturing in the United States (US), the Purchasing Managers’ Indices (PMIs) in China, Korea, and Taiwan, all surprising to the downside. So, the manufacturing part of the economy is very weak. We also had Korean exports, for example, which were down by 14.5% in year-over-year terms.

This is probably the most important piece of hard data that is a leading indicator to the global manufacturing picture.

But the service sector remains extremely elevated, and within the manufacturing side, you can see that prices paid is under pressure. So, central banks still have this challenge of balancing an economy that is cyclically slowing down on the manufacturing side. Typically, that's the more important sector.

Against a backdrop where prices remain sticky, core inflation broadly across most countries is running above headline inflation, and even headline inflation in most countries is relatively elevated and at uncomfortable levels for central banks. But again, contrasting with this, is the point of the cycle in the manufacturing sector where central banks should actually already have paused and be thinking about easing monetary policy.

Stephen Rudman: All right. That's quite a lot of data. With that said, do any of those numbers change your thesis for 2023, which we know is for the first half of the year to be bumpy and rocky (which to this point has been pretty accurate), and then hopefully things starting to turn in the second half of 2023. So, as those numbers have described, do you think we're still on that path or may we be changing towards a different level?

Gustavo Medeiros: I think we're still on this path. This week we're going to have the US Federal Reserve (Fed) and European Central Bank (ECB) meetings. It's interesting that against this context, the Reserve Bank of Australia, which had paused its hikes in April, hiked policy rates again on Tuesday morning by 15 basis points, which was not what the market was expecting – the market was expecting a pause. It's precisely this tightening monetary policy that has significant lags and a cumulative effect, especially as global monetary policy tightening was the anchor for our call for a more cautious approach in the first half of the year. So, to the extent that central banks are still pursuing primarily their inflation targets rather than trying to worry about financial stability at the moment, that still keeps us more cautious in terms of our approach to risk appetite specifically.

Obviously there has been significant intramonth moves this year. We had a very strong January, a weaker February/March and a recent rebound again in April in terms of risk assets, especially if you look at the S&P. Trading has been dictated based on the moves of the top 10 companies of the S&P, one of the narrowest set of markets that we've had. This typically is a leading indicator for trouble ahead – markets going up in a very narrow path, finding very few companies driving the stock markets higher. That happens at the very final stages of boom market cycle. So, there are still too many signals pointing towards trouble ahead for us to be calling it a day and to turn more risk-on, if you will.

Stephen Rudman: Fair enough. With that said, over the weekend, we had another bank takeover in the US. To your point, as we're looking at the balance of 2023, do you think that this has any real global impact, or is this just the cleaning up of some bankers who maybe didn't run their bank properly?

Gustavo Medeiros: Well, there is a global impact to the extent that the global monetary policy tightening has been having an effect on the weakest links pretty much across the board. Obviously, the US has a much more fragmented banking sector, therefore you should expect to see more regional banks that could be in trouble by mis-managing their asset liability exposure in the cycle.

A lot of people are drawing comparisons to the Savings & Loan crisis of the 1980s, which I think is appropriate. Back then, Fed Chair Paul Volcker was driving a very aggressive monetary policy tightening programme, leading to significant problems on the balance sheet of the banks.

Today's issues have been compounded by the fact that, with a handheld mobile device you can basically take all your money out of the bank and you can notify all your friends of what you're doing. Nobody has to queue to take the money out of the banks and so it's developed much faster. For example, First Republic Bank suffered $100 billion of outflows in the first quarter of the year and it was a very similar setup from the Silicon Valley Bank (SVB) and Silvergate, the two first banks that went under, that were large in size.

Two points to highlight here. One, this still doesn't make for a systemic crisis in the similar ways to 2008-2009. The very large banks are extremely well capitalised and have huge cash balances. Therefore, it's unlikely this is going to be a systemic problem. But two, it doesn't mean that we're at the end of it to the extent that the big problem for the banks will come once the commercial real estate loan situation comes to a head. This is likely to be towards the very end of the cycle, especially if the Fed tries to maintain interest rates at a higher level for a longer period of time – which is a possible scenario given sticky inflation at the moment.

The longer the Fed, the ECB and global central banks keep interest rates at elevated levels, the larger the cumulative problems in the real estate sector, particularly in some of the weakest links there.

That's when we're going to have a crisis in the banking sector that will be very hard to backstop because for the moment most of what the Federal Deposit Insurance Corporation (FDIC) is doing is to backstop assets that are very easy to value, namely mortgage-backed securities that don't have a lot of credit risk or US Treasuries. These are assets that do not have a problem with their future value, they just have a marked-to-market issue at the moment.

The final issue is that the FDIC itself is estimating it is going to take $13 billion of losses on the bailout of First Republic Bank. JP Morgan acquired FRB on Monday. If you add that amount to the first two large banks bailed out, we're talking about around $35 billion of losses which is basically a little bit more than a quarter of the value of the FDIC.

In regulatory terms, FDIC should keep more than 1.35% of the total deposits in the system to backstop potential problems. Today, it has less than 1% of insured deposits, and the long-term target of the FDIC is 2%.

What we learned is that the FDIC is going to have to replenish its cash buffers and we haven't yet started to see the problem move to commercial real estate loans. All in all, I think we're going to see more chapters on that story. Maybe it's going to take some time for other regional banks to go under, it might take a few weeks, maybe a few months, but I find it hard to believe this is the end of it as some commentators have suggested.

Stephen Rudman: Thank you. So, to paraphrase, it will have some impact as we move forward into 2023, but not necessarily the version we've seen so far. One last question as we have the time, I know we're running into a very busy political agenda in Emerging Markets (EM) over the next few weeks and months. Perhaps you can highlight where those things are happening and where any concerns or potential opportunities may lie?

Gustavo Medeiros: Sure, there's been a lot going on in the political space in EM. Last weekend for example, there was an election in Paraguay where the incumbent won. It's a market-friendly regime at the moment in Paraguay, so that's good news.

We also have really good news coming out of Indonesia where the Governor of the Central Jakarta province, Ganjar Pranowo, announced he's going be stepping up for the ticket. And current president Jokowi is trying to cut a deal for his current defence minister an eternal presidential candidate, General Probowo Subianto, to join the ticket. If that happens, two out of the three major candidates will be on a unified ticket very likely to be supported by Jokowi. Also importantly, Ganjar Pranowo is very supportive of the market reforms and the direction of travel taken by Jokowi, which is very positive.

And in two weeks' time we're going to have on the 14th of May presidential elections in Thailand and Türkiye. In Türkiye, we have Erdogan trying to win yet another term as president after a disastrous earthquake that shattered south of the country. It's a very tight race where the odds of the opposition gaining power are slightly ahead of the odds of Erdogan winning re-election. But if you look at the poll of poll surveys that we have, we're talking about the gap of 2-8% in favour of the opposition at the moment. So, it's too early to say.

Despite the opposition having a much better framework for macroeconomic policies, the policies Erdogan put in place over the last 10 years have brought so much instability and so many problems to Türkiye’s balance sheet, like the central bank having negative net reserves and way too much credit expansion hiding potential fiscal liabilities beneath the surface. I really think it's going to be hard for anybody to right the ship without any significant currency devaluation and the impact of that.

On the other hand, in Thailand, whoever manages to become the next prime minister, we're likely to see very significant changes in macroeconomic policies. There are some elements that make us believe some of the post-election political instabilities seen in the past won’t  be repeated this time. The Thai population has grown tired of the economic slump following Covid-19, due to the low levels of tourism recovery so far, and they want to see policy normalisation. Most leading candidates have very thorough initiatives such as cash transfer programmes, and increasing minimum wage, which at the margin should reduce fiscal instability.

There's quite a lot going on in Latin America as well. Cristina Fernandez de Kirchner reiterated last week she's not going to be running for president later on this year which is an important signal for Argentina. In Colombia, Gustavo Petro just reshuffled his cabinet after failing to approve a healthcare reform.

Similar to what we've seen in Brazil, Peru, and Chile, even though we’ve had transitions of power towards the centre or far-left in some cases, parliament and the courts have been providing some checks and balances and these leftist administrations are struggling to implement heterodox policies that don't come to the centre. So, everybody has come to the centre to govern.

An interesting fact, both Gustavo Petro in Colombia and Lula in Brazil have been implementing fiscal policies that are much more austere fiscal programmes through their first year of the administration. In sharp contrast with the end of previous centre-right administrations of Iván Duque in Colombia and Jair Bolsonaro in Brazil. Iván Duque dragged his feet and did not allow for an increase on fuel, and kept on increasing the subsidies for the population which deteriorated Colombia fiscal accounts. In Brazil, Bolsonaro’s administration basically blew up the budget to try to get re-elected.

Now we get the centre-left or the far-left, depending on how you want characterise these administrations, actually implementing fiscal consolidation. Obviously, there's a huge amount of noise behind that and markets still perceive these administrations unorthodox and don't give the benefit of the doubt, but the facts are that you just have to look at the numbers to see that the left is actually driving for better fiscal policies than the centre-rights in Latin America over 2022 and in 2023.

Stephen Rudman: Obviously a lot to analyse and we will be watching all of those things closely, and most importantly, what the impact may be to markets both on a local, broader EM and global level. Gus, as always, thank you kindly. Wonderful update, as we continue to navigate what has been a very bumpy first half of the year, and all of this is helpful. So, with that, until next time, all be well and the very best. Thank you.

Gustavo Medeiros: Thank you very much.