How Will The Ongoing European Energy Crisis Impact Emerging Markets?
Emerging market equities continue to lag developed markets marginally in what is turning out to be a poor year for global equities. Aside from the much-talked about fears in the U.S. of recession, inflation and an aggressive Fed, the current major issue 'du jour' is the dramatic European energy crisis.
The current new 'news' is that Russia has announced that it will keep gas flows to Europe (through Nord Stream 1) shut off—a drastic step—while European sanctions on Russia stay in place. While oil exports from Russia continue to flow, various recent developments such as an 'oil price cap' on Russian exports, increased sales to China and India and a 100,000 barrels per day cut in OPEC+ output now seem less important given the sharp fall in oil prices over recent weeks. (Brent prices are down by 30% to $89 per barrel from their spiky March high.) Meanwhile, the real pain is in the natural gas market where European benchmark Dutch TTF futures are up five times since mid-February.
In simple, brief terms, how do these factors impact EM equities?
European growth will be very badly hit by surging gas prices. These—along with current events in China—will put the global economy at significant risk of recession over the next few quarters; inflation will also rise, putting pressure on European central banks.
Parts of the EM index (especially Central Europe and Turkey) will be DIRECTLY affected by this awful growth/inflation combo. However, Czech Republic, Hungary, Poland and Turkey are tiny markets in the EM index (combined weight of 2.5%); by contrast, Europe at end-August was 17% of the DM index.
These overall European events have pushed the U.S. dollar still higher, as it breaks through parity with the Euro; a strong dollar is, as I have always argued, a negative for EM equities.
Higher oil prices (although not the biggest issue at present) are typically seen as very negative for major EM oil importers such as Turkey, India and some other big Asian economies such as Korea and Taiwan.
On the upside, there are 'relative safe havens within EM to these recent events such as the Middle East (with their oil exports and sustainable dollar pegs) and commodity-rich Latin America; MSCI Latam is flat this year, led by an impressive gain in Brazil (+4.8% in $).
So, what does all this mean?
All global equity markets will be challenged as a gas-starved Europe reels under recession/inflation pressure.
Any new USD gains will be negative for EM, although I retain the view that ongoing strength (rather than a major further advance) seems the likely outlook for the (overvalued) dollar.
Meanwhile, this heavy market focus on the European energy crisis will likely allow EM equities to continue to trade 'relatively' well versus DM—which is very unusual in down markets. The last year that DM fell by more than 20% (2008: -42%), EM fell 54% during the Global Financial Crisis.
The author is an independent emerging markets commentator; Adjunct Assistant Professor, St. Mary's College of California.
The views expressed here are those of the author’s and do not necessarily represent the views of BQ Prime or its editorial team.