We entered 2018 conscious that the asset reflation regime would have switched to a late financial cycle in H1, with central banks finally recalibrating their monetary policy stance and the global environment becoming progressively more challenging. As a consequence, we adjusted allocations to prepare for less liquidity, higher volatility and, eventually, gradually lifting interest rates. Our rationale to investing was risk rotation and progressive mitigation, however, at the end of Q1, rising tensions on global trade and the US’s unexpected fiscal supercharging shifted our attention from inflation expectations and rates to the global trade slowdown and its spillover to global growth, EM in particular. At the same time, in the US the fiscal policy measures supported further profit expansion and eventually boosted the US financial market. The USD strenghend, treasury yields and oil prices increased, putting pressure on EM. We note that excesses have been accumulating over time amid liquidity abundance, while financial imbalances continued to build up. We now see a potentially dangerous configuration of financial forces related to the late credit cycle deterioration, a stronger USD, an elevated leverage (both in public and private sectors, with different distributions in DM and EM between the two sectors) and less supportive equity and credit valuations. Tariffs and raising trade barriers, tighter labour market conditions and the consequently higher unit labour cost, and the higher producer price index (higher oil prices) are starting to weigh on profit margins, more so than on headline inflation. In the EM, financial conditions have broadly tightened. The intensification of domestic political concerns in some cases, a stronger USD and higher US rates generated capital outflows (for the time being these are largely contained in the fixed income space and more evident in equities). This could prove to be potentially risky for those countries that have large borrowings without adequate capital buffers (Poland, Chile, South Africa, Turkey). |


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