Traders look past Ukraine angst to load up on emerging assets

[NEW YORK] Emerging markets are standing firm despite escalating tension along the Ukrainian border, with investors more closely eyeing the impact of major central banks catching up on the global tightening cycle.

From stocks to local currencies, pockets of emerging markets are on the up. Aggressive central banks and high commodity prices are driving advances this year in more than half of the 24 developing-world currencies tracked by Bloomberg.

Analysts have sent corporate earnings expectations to an 8-year high. And investor risk appetite is holding strong: South Africa, considered a bellwether for emerging-market risk, is the best performer this month in the local-currency debt market with total returns exceeding 6 per cent.

"Emerging-market assets have been fairly resilient through the past several months of elevated Russia-Ukraine tensions," said Phoenix Kalen, head of emerging-market research at Societe Generale in London.

"Increasingly, Russia is treated as an idiosyncratic story, which implies limited contagion risk into other emerging markets via the investor sentiment channel."

While Wall Street is closely watching developments in Moscow and Kyiv, some money managers say the more important development will be how much the Federal Reserve and other key central banks affect global growth by raising interest rates and pulling back the massive stimulus pumped into the financial system since the pandemic.

"The big driver will be another war - that war being global organic growth versus the tide of liquidity and fiscal stimulus receding in the global economy," said Jack McIntyre, a portfolio manager at Brandywine Global Investment Management in Philadelphia, who said his base case is still that tensions between Russia and the West will ease.

"Emerging-market assets have priced in a significant amount of bad news over the past decade and therefore we don't think there will be a major repricing."

But deeper geopolitical risk is still there. Signs of a protracted and severe military conflict could shock global markets, growth and inflation. That's been underscored in the past week as markets were whipsawed by reports signalling easing or escalating tensions.

The US said Russia has massed as many as 190,000 personnel in and around Ukraine. While Russia told the US it has no plans to attack, the Belarusian Defense Ministry said Russia and Belarus will extend their joint military drills, which were scheduled to end on Sunday (Feb 20).

Most emerging-market currencies edged higher Monday on news of the proposed summit between US President Joe Biden and his Russian counterpart Vladimir Putin, according to statements from the White House and France. There was no immediate confirmation from the Kremlin.

Political risk in Russia has risen every day since Nov 7, according to a GeoQuant measure. Yet, it has coincided with a rally in emerging-market currencies that's sent their benchmark gauge to the highest in 8 months. That suggests traders' optimism over successive interest-rate hikes may outweigh concern over the geopolitical tensions.

Still, a spike in oil prices if Russia were to invade could lead to a performance gap between emerging-market energy importers and exporters.

Already, elevated crude prices may linger due to supply-and-demand dynamics, which could underscore opportunities in the Middle East - a region already showing robust credit fundamentals, said Anders Faergemann, London-based senior portfolio manager for global fixed income at PineBridge Investments, which manages US$149 billion.

For Societe Generale's Kalen, central European currencies from Poland, the Czech Republic, Hungary and Romania are among the most vulnerable to Russian escalation and could see selling if risk aversion grows in the region.

Uncertainty has also hit Russian assets. The ruble is down more than 3 per cent so far this year, but the largest US exchange-traded fund (ETF) tracking Russian equities, the VanEck Russia ETF (RSX), is fresh off 5 straight weeks of inflows.

Such volatility hasn't stopped BNP Paribas Asset Management or Legal & General Group from hanging on to more bullish calls on regional assets. BNP is keeping its Russian and Ukrainian fixed-income holdings with a strategy to stay nimble by avoiding the 10-year part of the yield curve, said Jean-Charles Sambor, the firm's head of emerging-markets fixed income in London.

"My base case is that there is not a full invasion into Ukraine, but rather the 'frozen conflict' continues, as it has for the past 8 years," said Uday Patnaik, a London-based money manager at Legal & General Group, who recently added to his holdings of dollar bonds issued by Kyiv-based Kernel Holding and MHP.

"It is not new. It is one of the reasons that Ukraine trades relatively cheap." BLOOMBERG