Emerging market

The IMF has released the new world economic outlook (WEO), and a useful graph (for the current environment) shown below examines the impact of inflation on emerging market currencies.

Generally speaking, they sell-off. No surprise at all, but, worth reiterating if you have substantial EM exposures, and inflation proves “less” temporary than thought, you may prefer hedging out the EM FX risk, to the extent that the product selection permits.



This next graph, not from the IMF WEO, does a good job of showcasing why we still think “transitory” is the right frame for thinking about inflation. The massive US stimulus packages from 2020 and 2021, in both gross and net terms, fade very quickly over forward estimates.


Similarly, the new measures proposed by Biden (this recent bill that’s cleared the Senate) have much smaller (by way of comparison) impacts, spread over much longer periods of time.

It is unlikely, we’d suggest, that you would have unanchored inflation expectations on that basis.

Again, why does all this matter? Well, inflation ultimately determines interest rates, and likewise employment, so a view on inflation is a proximate bet on both of those things, which in turn influence corporate profits and foreign exchange rates.

So a view on inflation is pretty essential when forming a view on markets, and then of course, which markets (e.g. where do you see/forecast/guess inflation will impact the most?) and at what hedging level. And so on.

And that’s before talking about bonds, where the decision to use inflation protected securities (e.g. TIPS) is a viable alternative, as are floating rate notes, and ETFs that allocate heavily to those sorts of securities. Fixed rate long dated bonds clearly have duration risk in that context, and so you’d be reconfiguring both the portfolio’s overall duration, as well as stock/bond mix.

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