A woman photographs the container ship Ever Legacy, which was unloaded from Taipei in the port of Los Angeles, the busiest container port in the country, on March 6, 2020 in Terminal Island, California.
Mario Tama | Getty Images
Bank of America believes that emerging market inflation may be on the horizon as global demand returns and supply constraints are likely to drive shipping, food and energy prices higher.
In a statement distributed on Sunday, David Hauner, Cross Asset Strategist at EEMEA, emphasized that while markets are pricing in the highest US inflation in a decade, emerging market expectations are not catching up, even though they are typically more inflation-prone than developed countries.
One of the first signs that a surge in inflation could be imminent in emerging markets was the recent surge in freight rates, according to Hauner, as a resurgence in world trade and capacity constraints among airlines cause supply constraints. BofA analysts also expect oil prices to double from 2020, and note that food prices are accelerating.
“Normally base effects should be ignored, but we expect them to be a concern in a market that is already nervous about US inflation,” said Hauner.
Spot container freight rates are currently at record levels, three times what they were at this point last year and twice the full-year 2020 average, although major airlines like Maersk expect them to be down in the second quarter of 2021 and beyond will normalize.
While the long-term outlook is more balanced, he suggested that upside risk remain higher than usual and advised investors to take the opportunity to hedge.
“Another worldly disinflation factor is waning: the supply of workers to non-workers is about to peak when deglobalization and lower savings rates are likely to increase costs,” said Hauner.
“In contrast, automation remains a major antagonist to inflation. The balance of these forces is likely to determine the future of long-term EM inflation.”
Hawkish central banks, resilient balance sheets
Hauner recommended buying currencies backed by Hawk central banks or a solid balance of payments – namely the Brazilian real, Chinese yuan, Czech koruna and South Korean won – along with oil exporters, particularly the Russian ruble and Russian stocks.
“In the emerging countries, an environment of rising inflation and rising interest rates favors markets that are resistant to higher financing costs and actually benefit from rising raw materials,” said Hauner.
“These include, for example, Russia, Saudi Arabia and the United Arab Emirates (UAE). We like Russia for stocks and foreign exchange and Dubai for stocks.”
Currencies in countries where central banks are most likely to raise interest rates to contain this pressure are most likely to benefit, BofA analysts said.
“In addition to the RUB mentioned above, we also like BRL, CNH and CZK as well as KRW as proxy for China for this reason. In terms of interest rates, we like bearish positions in low-yielding companies like Hungary or Poland.”
Hauner and his team suggested that the evidence overall tends to be in favor of investors and offers at least some protection against higher inflation in emerging markets.
“The risks appear to be asymmetrical: at the moment, markets are little concerned about mounting price pressures. Upside surprises are likely in the coming months and could make markets more nervous about the longer-term inflation history,” he said.
“Even in the long term, the reflationary forces seem to be stronger than they have been in the long run (looser macro-politics, de-globalization and demographics), although we also welcome the argument that automation will keep inflation under control in emerging markets despite these factors.”