Why a little convergence in global growth could be good for Emerging Markets
Rising US growth outperformance has been a key feature of the macro environment in recent months. We think this is now turning as US growth is likely to moderate from the strong pace in the second quarter and converge somewhat with the rest of the world. We think this convergence creates the potential for a comeback in emerging market (EM) assets. More broadly, we prefer equities over credit and credit over rates.
1. US exceptionalism has peaked.
We think the period of diverging growth rates—driven by strong US outperformance—is largely behind us. US growth benefitted from strong support from fiscal policy in the second quarter, which is likely to fade over time.
2. Interest rates are likely to remain near current levels into year-end.
We expect US interest rates to continue climbing over the longer term, but we see few catalysts for another significant move higher this year. With inflation rising gradually and US growth likely to moderate, we expect the Federal Reserve (Fed) to raise rates twice more in 2018, consistent with market pricing.
3. A challenging investment environment, but fertile for an EM comeback.
Trade tensions, political developments and the potential for a moderation in US growth raise the risk of a temporary pullback in equities later this year. However, we think US growth will remain above trend and economic fundamentals in most EM countries remain healthy, creating fertile ground for a comeback in EM assets.