UBS Equities-Global Strategy _Where next for EM FAQs and where the conse...-114587340

ab9 April 2025Global ResearchGlobal StrategyWhere next for EM? FAQs and where the consensus stands on EMIn this note we address, briefly, recent EM FAQs from clients:• Which effect will dominate EM currencies - rebalancing out of the US, or weaker growth?• How close has EM risk sentiment come to ‘capitulation’? • Where are growth risks higher: the US, or EM? Is friendshoring cushioning EM growth?• Which asset classes/markets may be most exposed if the downturn extends?• Where is value being created in the selloff? Where should one hide?• Is there still value in local debt? Who may be forced to hike rates as FX falters?• What if the CNH weakens to 7.7/$?What levels on MSCI EM & EMBI would present more compelling risk/reward?We warned in January that tariff risks weren't being properly priced into most EM assets, but with bigger and broader tariffs than we were ever expecting, where to from here? The good news is that our EM risk appetite index has fallen rapidly, to ~0.75 s.d. below neutral, from 1.0 s.d. above neutral last Tuesday. At the pace the market is moving, EM is less than a week away from triggering a 'capitulation' signal in risk sentiment (1.5 s.d. below neutral) that historically represented a strong 'buy' signal 1-2q out (historical median MSCI EM returns +11% over the next 6m). We regard today's RAI signal as a necessary, but not yet sufficient condition to engage more positively in EM equities, FX and credit, though risk/reward is clearly improving after sharp repricing. Our main concern is unusually elevated EM growth risk; we have highlighted weak initial conditions for EM growth prior to these tariff hikes, and see the impact being a global synchronised slowdown well beyond reciprocal tariff rates. It isn't clear to us at this stage that EM growth will avoid a hit comparable to the US. Risks to elevated EM earnings expectations thus appear firmly tilted to the downside, and credit valuations have by no means yet overshot. We would see potential EMBI spread widening above 500bp / MSCI EM declines below 940 presenting more compelling risk/reward for turning more constructive on these asset classes (currently 386bp and 1002 at the time of writing).Local debt, currency neutral has been our favoured asset class and remains so for now. Brazil, Mexico, India, Korea (and potentially Colombia) 5y rates are still attractive, we think. By contrast South African FRAs offer weaker risk/reward on FX weakness. In FX we believe the forthcoming global trade recession will dominate portfolio rebalancing for several Asian currencies (short SGD, IDR, THB, INR vs. DM currencies), while cyclicals elsewhere (CZK, MXN & COP) also appear vulnerable. The consensus has pared back expectations of a weaker RMB until today, and a move below 7.6/$ would be a clear risk to the rest of EM. BRL & TRY are our preferred FX longs over the next 2-3m, and KRW already screens cheap - these are right-tail candidates on earlier-than-expected tariff rollback. In equities