Emerging Markets: Stirred, But Not Yet Shaken

It's been a wild year for markets, with risky assets performing strongly through February,

but reversing much of their gains as oil prices spiked in response to the Iran conflict.

So where do markets go from here? I'm Allison Nathan and this is Goldman Sachs exchanges.

Joining me here in London is Kamaksha Travedi, chief foreign exchange and emerging market

strategist in Goldman Sachs research. Kamaksha, welcome back to the program.

Thank you, Allison. It's a pleasure to be back. Obviously, it's a very uncertain time for markets,

so we have a lot to talk about. First, just get us up to speed on how markets are digesting

the developments in the Middle East. It is a very uncertain time and lots going on, so I would

make three high-level observations. First, I think the market is pricing in a higher inflation

shock in response to the spike in energy prices that you've seen as a result of the conflict.

You see that in the way rates curves have moved up, generally, places that were pricing cuts,

central banks that were priced to cut rates. You've seen those cuts come out, places that were

priced to be on hold. You've seen more hikes and priced into those places. So the UK, the US,

where we were expecting to see cuts, the market is pricing fewer cuts there. It's pricing higher

inflation overall. I think the second thing that is quite striking through these last couple of weeks

is that things that people had on as hedges for portfolios has broadly speaking not worked.

So long duration, people being long interest rates, I think that hasn't really performed. People

got comfortable with long gold positions. Those haven't really performed. The Swiss franc was

another popular geopolitical hedge. That didn't really perform. And so generally, it's been quite a

painful period for portfolios in part because those hedges haven't worked. And then the third and

final thing I would say is that while equities broadly have moved lower, there hasn't really been

a very clear cyclical growth he tilt to that move. Assets that you would typically think under

perform when growth is under pressure, things like the Australian dollar, copper prices, cyclical versus

defensive rotations in equity markets, that hasn't really gone down in a meaningful way. And so

I think to sum up, it's been an inflation shock that the market has priced across assets.

It hasn't really been a growth shock that's been priced. That's the shoe that's left to drop.

If the conflict sustains for longer, I think that's the area that I would be most concerned about.

So why aren't those hedges working? I think it's a number of things. I think positioning is a big

part of it. I think you saw really a kind of quite a large amount of people rotate into very

concentrated small markets like gold. You've seen something similar happen in some of these

other places. In the case of duration or US interest rates, you've got a shock in terms of inflation

that actually pushes against some of that from a rate standpoint. And so I think there's a few

different reasons. In the case of the Swiss franc, there were comments and past experience that

people remember that at times of such shocks, the central bank can intervene to stop the currency

from appreciating. So for a variety of different reasons, whether something to do with positioning,

something to do with policy actions, you didn't quite see those hedges function in the way that

people were expecting them to. And it's interesting that you say that there is another shoe to drop

because the market really isn't pricing a growth shock at this point. Is that just because the

market isn't wait and see mode and we just need to see more developments before it would?

I think there is some of that. I think at some level, it's pretty rational. I think what is

happening here in the sense, we are still early, let's put it this way, in this evolution of this

conflict. I think markets are trying to get a sense of the full extent of the energy price

increase to kind of price that inflation shock. How big is it going to be to what extent our policy

make is going to have to respond to that with tighter policy? I think once they can put some limits

around the size of that inflation shock, I think typically you move on to pricing and what the

growth damage is going to be. So I think that sequencing that you're seeing is not completely

unlike what you have seen in prior shocks of this kind. I do think that one of the things that

is going to come into focus very quickly, if we don't see this settle or at least deescalate

in the next few days, is whether there are actual physical shortages in places. And then that's

going to create growth damage that might be much quicker than just what the price mechanisms might

bring about. So the dollar has strengthened amid all of this. What role is it playing here?

Look, I think the dollar, as you said, it's been stronger in this period. If you step back and

think about it, yes, there have been some shifts in the correlation of the dollar with risk assets,

but I think the kind of shock we've seen where it's a global risk event. That risk event is

occurring or emanating from somewhere outside the US. And it's one where it's led to a big energy

price shock, where the US is on the right side of the terms of trade divide that move the higher

energy prices, what that means for your import prices versus your export prices, the US is on the

right side of that. So a global risk of shock and the US being on the right side of that divide,

I think both of them lends itself to a stronger dollar. That's what we have seen across a whole

range of currencies. But I would say like when you look across global effects, actually the reaction

has been fairly orderly. Initially, it was very much a risk of a risk unwind that was the biggest

explanatory factor of what's driving different currency pairs. And people came into this event

being short dollars and the dollar unwind some of that. But as the crisis has gone on, as energy

prices have stayed high, what you're actually seeing is that second axis of differentiation terms

of trade, who is an energy exporter and who is an energy importer, that fundamental axis has become

a bigger differentiator of global currency pairs. The US dollar is on the right side of that, as long

as that pressure on the energy prices remains to the upside, I think the dollar will remain well

supported. I want to dig into that a bit more on the emerging market side in particular. They

obviously a lot of emerging market assets, equities in particular have had a very strong year

prior to the start of the conflict. So has that narrative on the emerging market side fundamentally

changed at this point? I wouldn't say it's fundamentally changed, but definitely that strong

momentum has been interrupted quite meaningfully by what has happened. Again, within emerging markets,

you're seeing some of the same dynamics at play that I mentioned that was true of global markets. So

those two dimensions, one, an unwind of accumulated positioning, that was a good way of seeing where

you saw the biggest underperformance places that had done the best in the months leading up to it.

Both emerging markets were an example of that asset class, but even within emerging markets,

you saw that in places like Korea, a market that had done phenomenally going into it,

was one of the biggest underperformers as a result of the crisis. And so positioning did play a

role, but the second thing is again, the terms of trade shock. A lot of emerging markets,

particularly in Asia, also parts of Central Eastern Europe, are energy importers. And so they face

the direct hit to their import bills, to their balance of payments as a result of high energy

prices and down the road potentially at growth shock as well. And so you've seen both of those

interrupt that very strong performance of emerging markets. I don't think it fundamentally changes

the narrative if the conflict is short-lived like commodity markets are pricing it. The highest

point in energy prices at the very front month of the futures curve, the market is pricing

this to be a relatively short duration conflict lasting weeks rather than months. If that's the case,

then I don't think it fundamentally changes the narrative. Obviously if it lasts a lot longer,

I think it puts into question some of those growth estimates that we expect.

And some of that narrative for Korea, for example, is tied more to the AI theme,

which we generally think is going to endure, correct? So if you think beyond the war,

if it doesn't turn into a prolonged disruption in energy, what are we expecting for some of these

markets? I think that's absolutely right. So if I think about start with the bigger picture on

emerging market, equity is for example, we're expecting something like 10 to 12 percent upside

from current levels. A big part of that or almost all of that is coming from earnings growth. We

expect very strong earnings growth through the emerging market universe. Korea is the poster child

of that earnings growth. Why is it having that very strong earnings growth? It's the AI theme. It's

the fact that Korea, Taiwan, some of these North Asian markets supply the all-important chips,

semiconductors into this kind of AI supply chain. And the demand for that and the pricing power

that these firms have is second to none. That's not going away anytime soon, absent a kind of

global recession, not something that we expected this stage. And so as you look past this interruption,

as a result of the conflict, I think some of that earnings power is very much in place.

I think some of the upside that we expect from that earnings, from people coming back into that,

from now more somewhat more neutral positioning levels, I think should also be quite a big boost

to those markets. We do have a thing that makes sense as you look at emerging markets broadly,

to balance some of those more digital AI exposures in places like Korea, like Taiwan,

China, with other macro factors. So places like South Africa, Brazil is a good example of a place

which is an energy exporter that has got hit as a result of the risk unwind. So you have a kind of

domestic market that's an energy exporter that's on the right side of the terms of trade divide

that should do well with the kind of shock that you've seen but has obviously gotten hit as

risk has been taken down everywhere. As the dust settles if the conflict deescalates,

I would expect to see some of these other commodity exporting markets like South Africa,

like Brazil, do once again consolidate and do better. And if you think about beyond the

cyclical story and really some of the structural drivers, are those also supporting emerging markets,

how do you think about this if you take a step back? Yeah, I think they are and I would point

to three structural drivers, right? Let's start with the dollar. We talked a little bit about the

fact that here and now in this crisis, the dollar is well supported on the back of this energy shock.

However, when you think about the dollar in a longer term perspective, it's still an overvalued

asset and we think that valuation premium in the dollar is going to erode as the US macro and

market performance looks less exceptional in coming months and years. That slightly weaker dollar

trajectory is generally a big lift, a big tailwind to emerging markets. We think that's one of

the things that is going to persist and come back into play once this conflict deescalates.

I think on the emerging market side, the macro factors are still pretty resilient. Growth is good,

inflation is in a better place. It's come down after the pandemic surge, fiscal deficits and

current accounts before this shock were again in a healthier place and generally policy frameworks have

evolved to a point where I think emerging market assets are much more resilient than I think

people's memories of them suggest. It's a less racy asset class. It's a more reliable asset class.

I think that's what people are going to discover even as we go through this shock. And then the final

point is allocations. I think people are still somewhat underweight emerging market assets. If you

think about it in a global allocation, EMs are roughly 12% of the overall benchmark. On our estimates,

people's allocations in global equity funds are about 10%. So emerging markets, even after

the strong run they had in 2025, even after the strong run they had in the first couple of months

of 2026, asset allocators are underweight this asset class. And even after the underperformance

that we have seen in the last two weeks, EM equities are comfortably outperforming EM equities

and US equity. So the broader trend towards diversification towards allocating the marginal

dollar into emerging markets into global assets, I think that's the trend that's going to continue

and extend further. So that's the third thing that I think will be supportive.

I think it's an interesting point you make come actually especially at moments like this where we

have a supply shock. People often think that emerging markets are in the crosshairs, but much has

changed and that's not necessarily the case. I think that's right. I think that they are going to

feel the shock. They are going to feel the pain like everyone else has. This is a serious crisis

and if it lasts longer, I think we will have some growth impacts like I mentioned that will ripple

across the world. But the starting point for a lot of these countries, a lot of these markets

is healthier than it used to be. And I think that is going to stand them in good stead.

Thanks so much for joining us, Kamakshia and providing some insight into this pretty confusing

volatile time. Thank you, Allison. This episode of Goldman Sachs exchanges was

acquitted on Thursday, March 12, 2026. I'm Allison Nathan. Thanks for listening.

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