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In the last couple of years, election surprises seem to have been the rule rather than the exception. Great Britain, Germany, Japan and the US are all examples, with these countries continuing to experience considerable fallout from the results. In my opinion, we ain’t seen nothing yet — by the close of 2018 there will have been 24 elections within emerging market (EM) countries. Each brings the risk of significant policy change, good or bad. Markets don’t like uncertainty, so EM volatility has jumped this year. We expect this volatility in emerging markets to continue as the likelihood of election surprises and non-market friendly policies is elevated.
Some results are in, but policy uncertainty remains
In recent elections, the anti-establishment movement continued its recent successful run. Leftist ideologies in both Chile and Colombia were defeated, but not entirely displaced. In contrast, Mexico and Turkey saw nationalist-leaning candidates take office, leaving markets on edge. In these emerging market countries, we are watching closely to see if campaign rhetoric becomes policy reality.
Presidential elections in Chile and Colombia went according to script (and more importantly, polls), and market-friendly outcomes occurred in both countries. Chilean center-right candidate and former president Sebastian Pinera defeated leftist senator Alejandro Guillier. Chile has been seeing solid mining and non-mining growth and we expect policy continuity from Pinera, a billionaire businessman.
In Colombia, it took two rounds of voting for conservative Ivan Duque to defeat leftist Gustavo Petro. Duque has promised to usher in fiscal prudence while boosting growth in the oil-centric economy. A key issue in the election was a peace agreement that ended over fifty years of civil conflict. Former President Alvaro Uribe was a fierce critic of the peace deal, and since Duque served as his advisor, there were concerns that Duque’s election would result in a disruption of the peace deal. So far, these fears haven’t materialized.
Concerns in Turkey and Mexico
In Turkey, incumbent President Tayip Erdogan won another five-year term, creating a powerful executive. The new constitution allows him to serve an additional term, meaning he could remain in office until 2028. Recently (and perhaps unsurprisingly), Turkey has been one of the worst performing emerging market countries across all asset types. For instance, the lira has depreciated 21% against the dollar and the yield on 10-year government bonds has risen by 727 bps year-to-date.1 Erdogan has pursued policies to concentrate power under the executive branch, limiting central bank independence and risking unsustainable growth. One-year deposit rates are at 20%.2 Fears that Erdogan is exerting too much control were partially realized after he dismissed the entire cabinet and appointed his son-in-law, Berat Albayrak, as the new treasury and finance minister. Following the appointment, markets were looking to the July 24 meeting of Turkey’s central bank to see if it would maintain autonomy and raise the policy rate to combat high and increasing inflation. A hike of about 100 basis points was expected from the Monetary Policy Committee, but markets were disappointed when it left rates unchanged.3 Both the appointment of Albayrak and the central bank’s inaction deepened the selloff of the lira and other Turkish assets.
Mexico’s July 1 election resulted in a decisive victory for front-runner and self-declared populist Andres Manual Lopez Obrador, or AMLO. His party, the National Regeneration Movement, also won a strong mandate in both chambers of the senate. Mexican assets were underperforming leading up to the election due in part to the political uncertainty. AMLO’s election created the risk that reforms completed under the previous administration (such as in the energy sector) would be reversed. Such a reversal could result in a material economic setback for the country.
Despite these fears, markets are now enjoying an unexpected honeymoon. Mexican assets have rebounded dramatically since AMLO acknowledged that market participants act as checks and balances against his political agenda.
Moreover, AMLO has been saying the right things (so far) to calm the markets. He has been conciliatory and has verbally guaranteed that he will respect the autonomy of institutions like the central bank while avoiding further threats to existing oil contracts. Near term, serious doubts remain over his ability to obtain the necessary resources needed to fund his social agenda (which could increase social spending by up to 2% of GDP4). The true test will come when his base realizes his promises may have been just that … promises.
More volatility ahead
What does this mean for EMs? There are two key implications. First, the signaling around policy objectives has become more important for countries where more populist arrangements now reign, such as Mexico and Turkey. This dynamic may induce a fair bit of market volatility. Second, and more importantly, the prospects for diverging policy paths across the EM landscape are enhanced.
Additionally, we believe that financial conditions in the US have tightened due to the normalization of the Fed’s balance sheet and increase in policy rates. As noted in our recent blog (EM opportunity knocks — what to make of the recent market volatility), we believe that tightening financial conditions in the US coupled with policy uncertainty will lead to increased volatility in EM asset prices.
1 Source: Bloomberg L.P., July 24, 2018.
2 Source: Bloomberg L.P., Invesco, July 23, 2018.
3 Source: Bloomberg L.P., July 23, 2018.
4 Source: The London School of Economics and Political Science, “AMLO’s national plan for Mexico is a cause for optimism”, July 7, 2018.
Blog header image: Alexandros Michailidis/Shutterstock.com
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
Senior Portfolio Manager
Sean Newman is a Senior Portfolio Manager for Invesco Fixed Income. In this role, he is responsible for the coverage and analysis of emerging market government bonds.
Mr. Newman joined Invesco in 2013 and has close to 20 years of investment experience. Prior to joining Invesco, he was a portfolio manager covering emerging markets sovereign/corporate debt for GE Asset Management. Previously, he was an assistant portfolio manager for GE Asset Management on the Emerging Market Debt team. Mr. Newman began his career as an analyst at GE Capital through the Marketing Risk Leadership program before joining GE Asset Management’s Financial Planning and Analysis group.
Mr. Newman earned a BS degree in management and accounting from the University of the West Indies in 1994 and his MBA from Howard University in 1998.