A recession seems to be the only way to stop the rapid rise in inflation, says Federico Kaune, head of emerging markets fixed income at UBS Asset Management. In the report 'Bye Bye Globalization, Hello Stagflation', he explains what this means for emerging market bonds.
While inflation is going up, economic activity is coming down. PMIs and surveys in DM and China indicate that much, says Kaune. “Most recent official forecasts on real GDP growth in 2022, confirmed the trend. On the one hand, tighter monetary policy, and a negative fiscal impulse – following the hyper expansions of 2020-21 – would negatively affect growth. On the other hand, new Covid waves (now in China), ongoing supply constraints, and more importantly the negative impact of falling real incomes (compliments of very high inflation rates) will affect private sector consumption. Usually, high oil prices have the same impact as a tax on global consumption, now it is not only the oil prices that have gone up. Food has gotten more expensive too. Another factor affecting growth prospects is the low level of sentiment indicators in the Eurozone and the US, which have predictive power on growth six months hence.”
According to Kaune growth is also likely to be underwhelming in 2022. “Among the big ones, the Chinese authorities are struggling to turn around its economy, despite indications from the leadership that macroeconomic stimulus may be warranted, besides specific measures to alleviate the downturn in the real estate and tech sectors. In the absence of a turnabout in the general policy stance, it will be difficult for China to reach its stated growth target of around 5.5% in 2022.”
The main risk down the road for growth is inflation and the policies required to bring it under control, particularly in DM, says Kaune. “Monetary policy rates in real terms are highly negative and would need to make up a lot of room in a relatively short period of time. If past experience is of any guidance, a recession may be the only way to bring inflation under control, given the policy mistakes of the recent past.”
Key takeaways from the report:
- Emerging markets fixed income delivered negative total returns in Q1, mostly reflecting the Russian invasion of Ukraine and higher global inflation.
- Global inflation reached levels not seen since the 1970s due to higher food and energy costs.
- EM central banks are far more advanced in their tightening cycles vs developed markets as they responded earlier to imported inflation pressures and the depreciation of their currencies in 2021. However, the recent commodity shocks are likely to require further hikes to contain inflation expectations and second round effects. Emerging markets fixed income delivered negative total returns in Q1, mostly reflecting the Russian invasion of Ukraine and higher global inflation.
One of the most immediate consequences of de-globalization is higher inflation.