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Last weekend’s failure in Doha to reach an oil production agreement amongst the top world producers, had a weaker impact than initially feared on oil prices and financial markets alike, leading questions to be raised on whether markets have priced in a bottom for oil prices and whether confidence in a recovery is gaining ground.
Expectations on Monday were for oil prices to slide and risky assets to sell off. Despite this, oil merely closed 150 basis points lower, with no significant sell-offs across risky asset classes. The implication of a perceived bottom for oil may be good news for investor risk-on sentiment as well as commodities.
Emerging markets (EM) have an abundance of companies operating in the energy and commodities sector. The crisis over the past year coupled with worries of an appreciating USD has sparked significant capital outflows and has led investors to undertake underweight positions on emerging market assets, specifically on asset classes denominated in local EM currencies. The majority of debt financing in EM is financed in USD, hence an appreciating USD adds further burden to such companies whose local currencies have depreciated sharply over the past year.
Comfort has emerged to ease concerns of a further USD appreciation, however, as an influential member of the US Federal Open Market Committee (FOMC) on Monday admitted the Fed would remain cautious in raising interest rates given the presence of significant headwinds for a return to growth.
The dovish news coupled with a perceived bottom in oil prices, presents an opportunity to investors to reconsider dipping back into emerging economies. A stable USD and improving commodities sector allows for significant upside in undervalued EM assets, as a result of the sustained underweight position and capital outflows experienced over the past year. Having said that, it would be important to analyse such opportunities on the underlying fundamentals.
The situation in China supports the above investment consideration as fears of a Yuan devaluation and the draining of foreign reserves have lightened following the action undertaken by policymakers to tighten capital account rules and stabilise the currency against a basket of peers. The situation is still closely monitored but significant capital outflows are less of a worry to the broader EM economy.
The global volatility of late has increased the demand for safe haven assets, one of which has been the Japanese Yen. It has been debatable as to why the currency was considered a safe haven, however Japan’s status as the world’s largest creditor, sustained trade surplus as well as the ultra-loose policy measures of prime minister Shinzo Abe have been significant factors influencing investors. A policy meeting by the Bank of Japan at the end of the month may well affect the Yen.
The implications to investors may be little, however as a return to risk-on investment may be seen over the coming weeks, resulting in less inflows into safe haven assets. Left to see if a perceived bottom in commodity prices materialises to validate the EM opportunities to investors.
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