What's hurting emerging markets this year?

On the latest edition of Market Week in Review, Adam Goff, managing director, investment practice, and Sam Templeton, manager, global communications, discussed the August U.S. employment report, recent trends in U.S. equities and emerging markets, and the progression of budget talks in Italy.

Rise in U.S. hourly earnings punctuates strong August jobs report

The U.S. employment report for the month of August, released Sept. 7 by the Bureau of Labor Statistics, showed that the economy added 201,000 jobs last month, while the unemployment rate held steady at 3.9%. This was a very strong report, Goff said, adding that the real surprise in the latest numbers was wage inflation. “Average hourly pay rose 2.9%, year-over-year, and 0.4% on a month-to-month basis,” he stated, “an acceleration which, in my view, is certain to grab the attention of the U.S. Federal Reserve (the Fed).”

Why? In Goff’s mind, many of the reasons the Fed may have had to forgo additional interest-rate increases this year are likely to fall by the wayside in light of August’s strong showing. “Strong wage inflation and strong unemployment makes a September rate hike, in my mind, a done deal,” he said, adding that the latest numbers are also likely to bolster the odds of an increase in December as well.

Regulatory fears, trade war concerns unnerve U.S. markets

Despite the continued strength in the economy, U.S. markets had a choppy ride the week of Sept. 3, especially in comparison to previous months, Goff said. “It’s as if everyone came back from summer break, looked ahead and found several issues to be worried about,” he remarked. The tech sector in particular had a rough week, he noted, as testimony from several top tech executives before Congress sparked fears of more regulation within the industry.

In addition, looming fears around trade policy hung over markets, especially concerns about an escalation in trade tensions between the U.S. and China. “There’s certainly a little more fear in the U.S. market,” Goff concluded, “and while, overall, there wasn’t a huge drop throughout the course of the week, there definitely seems to have been a change in the sentiment and feeling of what might come next.”

Is a strengthening U.S. dollar to blame for emerging markets’ decline?

Broadening his gaze outside the U.S., Goff noted that the rough patch in emerging markets continued the week of Sept. 3, as worries about Turkey and Argentina continued to plague investors.

“At the crux of the matter is the fact that the U.S. dollar has risen steadily this year, and that means it’ll take countries like these—which have lots of dollar-denominated liabilities—that much more to pay back their debt,” he explained. Attention in particular has zeroed in on emerging-market countries with weaker institutions, Goff said, as investors ponder what measures these nations will take to shore up their economies and survive the strong dollar market.

On top of this, mounting trade concerns between the U.S. and China have also haunted emerging markets. “U.S. President Donald Trump’s recent comments that he plans to slap an additional round of tariffs on Chinese imports, coupled with waning positive vibes from proposed revisions to NAFTA (the North American Free Trade Agreement) helped to make the recent week a particularly rough one for emerging markets,” Goff noted.

Looking at the asset class as a whole, however, Goff and the team of Russell Investments strategists believe that the fundamentals aren’t too bad, Turkey and Argentina notwithstanding. “The key takeaway here is that these two countries don’t represent systemic risks for emerging markets as a whole—and certainly not for the world economy,” he stated.

Italian bond yields drop as budget concerns ease

Shifting to Italy, Goff said that worries around the country’s budget appear to be receding, which has led to a reduction in fear among investors. “Over the past several months, there’s been a lot of drama about how the new government may ignore the European Union (EU)’s rule on what a country’s maximum fiscal deficit can be,” he explained. However, Italian government leaders indicated the week of Sept. 3 that they will press forward with a 2019 budget that conforms to EU rules on budget deficit limitations, Goff said.

Simultaneously, in a bit of a surprise move, the Italian government bought back a lot of short-dated debt on Sept. 7, which also helped ease concerns about Italy reaching its debt limit, he noted. “Collectively, both these things led to fear coming out of the markets, as evidenced by Italian bond yields, which dropped significantly throughout the week,” Goff stated, adding that the recent development serves as the good news story of the week for investors.

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