A continued stalemate in the Middle East pushed oil prices higher in September. Together with renewed inflation fears and tighter central bank policy, it drove markets for the month, as the US dollar strengthened and sovereign bond yields rose.
Global growth data remain relatively resilient. However, Franklin Templeton’s Templeton Global Macro team says economies are absorbing these pressures in very different ways. In its view, this makes it essential to analyse each country on its own fundamentals rather than by region.
“The outlook remains highly uncertain given the current global backdrop, but we expect some countries to perform significantly better than others,” says Michael Hasenstab, chief investment officer, Templeton Global Macro.
Winners and losers from oil and AI
Energy importers and vulnerable economies are most exposed to the geopolitical situation and higher oil prices. Countries integrated into the global technology value chain, by contrast, are benefiting from a still-robust artificial intelligence (AI) demand cycle. That group includes a number of emerging markets (EMs) in Asia, among them South Korea and Malaysia, both of which Templeton holds in its portfolios.
The International Monetary Fund (IMF) expects similarly uneven outcomes in its latest growth outlook. Energy exporters outside the conflict zone, such as Colombia, Brazil and Ecuador, should benefit from favourable terms of trade. Economies plugged into the technology-led upturn are expected to see stronger activity even where they import energy. Activity is likely to weaken for energy importers with limited participation in the technology value chain.
“Resilience remains a broad theme across EMs, but differing sensitivities and policy settings require careful country-by-country analysis,” Hasenstab says.
The IMF continues to project faster growth in EMs than in developed markets. Asia is expected to keep outperforming, and Africa is also forecast to grow robustly. China remains important, particularly for other Asian economies. This year is the first of China’s latest Five-Year Plan, and a number of policies have been announced in recent months.
Global rewiring remains intact
Despite the conflict, Hasenstab says shifts in trade and economic relationships continue to support the team’s view that the global economy is being rewired.
“We expect global relations to continue shifting and realigning for some time yet, and we expect select EMs will benefit from these realignments,” he says.
The effects will vary with each country’s geography, political alliances and position in a reorganising global supply chain.
Local politics also matter. Markets reacted positively to new political leadership in Hungary and Colombia after elections earlier this year. Brazil will hold a presidential run-off on October 25 between incumbent Luiz Inácio Lula da Silva and challenger Flávio Bolsonaro, who won a greater share of the first-round vote. Serbia votes the same day in extraordinary parliamentary elections, after President Aleksandar Vučić dissolved the National Assembly on September 9. The United States holds midterm elections in November.
A tighter cycle and an overvalued dollar
The global monetary policy cycle has shifted towards tightening, although not all central banks have begun raising rates. A handful, such as Brazil and Kazakhstan, may still ease because of local factors, but most appear set to pause or hike. How far hiking cycles will go remains highly uncertain. The El Niño weather pattern is also expected to complicate the growth and inflation outlook in coming months.
Templeton still regards the US dollar as broadly overvalued and expects it to weaken further over the medium term. This is despite near-term support from geopolitics and tighter US Federal Reserve policy.
“We believe the ongoing asset allocation shift into non-US dollar assets is likely a sustainable trend, and the shift into EM assets reflects their structural improvements and greater role in the world economy, rather than just a cyclical opportunity,” Hasenstab says.
Many other countries are already raising rates or are set to. As a result, interest-rate differentials may also become less favourable for the US dollar.
Fiscal risk weighs on long bonds
The global fiscal outlook remains a key structural concern, particularly in core developed markets, although some EMs’ debt metrics have also deteriorated. The cost of the Middle East conflict is likely to put more pressure on the US fiscal position. In Japan, proposed fiscal measures point to continued pressure on debt ratios, and the same is true in Europe, where fiscal loosening will help fund the ReArm Europe program.
As a result, Templeton remains wary of longer-dated bonds, which it expects to bear the brunt of fiscal loosening. Hasenstab says the recent US debt buyback announcement will not offset these concerns unless it is accompanied by a significant fiscal adjustment.
Templeton’s core regional views remain largely unchanged. It sees value in specific countries in the Asia-Pacific region, including Australia, and in Latin America.
In Asia, it looks for countries that:
· have positive fundamentals and undervalued currencies
· are expected to be more insulated from tariffs
· are exposed to the global tech supply chain.
It is also watching for potential energy-shock effects. It holds a net-negative position in the Thai baht, as structural constraints keep economic growth in Thailand low.
In Latin America, it favours countries with prudent macroeconomic policies — including independent, proactive central banks — relatively high yields and undervalued currencies. It holds a net-negative position in the Chilean peso to manage risk. Because the peso has a high beta to other EM currencies, the position should help offset portfolio risk if markets become volatile.
Templeton also sees opportunities in select emerging and frontier markets, in both local-currency and hard-currency assets. Some portfolios hold African countries where reforms have materially improved fundamentals, notably South Africa and Egypt, as well as select frontier Asian markets. In Templeton’s analysis, these offer attractive potential yield pickup.
“We remain highly selective at the sovereign level, given significant variations in economic fundamentals and policy responses, particularly under current circumstances,” Hasenstab says.
