Fear of Floating Exchange Rates in Emerging Markets

Economic

Summary:

A Trump win in November could be the ultimate manifestation of this elevated geopolitical risk. More U.S. tariffs could see the dollar soar, putting emerging markets’ pegs under severe pressure.

Over 20 years ago, Guillermo Calvo and Carmen Reinhart coined the term “fear of floating” to describe reluctance in emerging markets (EM) to embrace freely floating exchange rates. Their work came in the wake of the Asian financial crisis, when many exchange rate pegs collapsed in explosive fashion, with large devaluations and financial turmoil weighing on growth in the years that followed. Since then, many emerging markets have embraced fully flexible exchange rates, alongside adopting independent central banks and inflation targeting. However, significant holdouts remain, even as they continue to suffer periodic currency crises and volatility. (There are also many dirty floats, i.e., countries who intervene periodically, especially in Asia).

Two things make currency pegs especially dangerous now: Strong U.S. growth versus the rest of the world caused the dollar to rise sharply over the past decade, and there is no end in sight to this outperformance; and Elevated geopolitical risk is leading to big swings in commodity prices, causing the terms of trade of commodity importers and exporters to fluctuate sharply. A Trump win in the coming U.S. election—if it leads to more tariffs—could be the ultimate such terms-of-trade shock, putting severe depreciation pressure on remaining pegs.

Fear of floating in emerging markets

Many emerging markets have shifted to fully flexible exchange rates with independent central banks, but a few countries have not followed this trend. Argentina is perhaps the most prominent example and helps illustrate the dangers inherent in currency pegs. It most recently devalued the peso in December 2023, whereafter it adopted a crawling peg to the dollar. High inflation in the wake of the devaluation pushed the real exchange rate back up to where it was before the devaluation, so any competitiveness gain has now likely been lost (Figure 1). Indeed, on a cross-country comparison, Argentina’s peso has risen the most in real effective terms across all major currencies since the COVID-19 pandemic (Figure 2). The rebound in the real exchange rate could have been avoided had the government allowed the peso to float freely after the devaluation, since nominal depreciation would have offset high inflation. Without that safety valve, the peso has once again risen to unsustainable levels.

Fear of Floating Exchange Rates in Emerging Markets_1

Fear of Floating Exchange Rates in Emerging Markets_2

Other prominent examples in emerging markets are Egypt (Figure 3) and Pakistan (Figure 4). In both cases, reflexive repegging post-devaluation allows inflation to push up the exchange rate in real terms, locking these countries into a cycle of devaluation. Fear of floating provides the illusion of stability in the form of a nominal currency peg, but this only produces instability and harms growth over the medium term. Other prominent emerging markets locked into similar cycles include Sri Lanka, Turkey, and Ukraine.

Fear of Floating Exchange Rates in Emerging Markets_3

Fear of Floating Exchange Rates in Emerging Markets_4

A uniquely bad time for dollar pegs

There are two things that make pegging to the dollar (the most prevalent peg) uniquely dangerous. First, the dollar has been on an uninterrupted rise over the past decade, as greater fiscal capacity and stronger growth in the United States than anywhere else have caused the greenback to appreciate (Figure 5). Any kind of dollar peg will inevitably shackle a country to this rise, damaging its competitiveness. Ecuador is the best example of this. It dollarized in 2000 and imported dollar strength in 2014-155, when falling commodity prices caused currencies in the rest of Latin America to weaken (Figure 6). Ecuador—a commodity exporter like many others in the region—suffered an adverse terms-of-trade shock, but—unlike others in the region—saw its real exchange rate rise. The result is weak growth and political instability.

Fear of Floating Exchange Rates in Emerging Markets_5

Fear of Floating Exchange Rates in Emerging Markets_6

The second reason why exchange rate pegs are dangerous is elevated geopolitical risk. The war in Ukraine and instability in the Middle East mean commodity prices may now be more volatile (Figure 7), which is driving large swings in the terms of trade of commodity importers and exporters (Figure 8). This volatility in the terms of trade makes it even more important that exchange rates be allowed to move freely. A Trump win in the upcoming U.S. elections could be the ultimate manifestation of elevated geopolitical risk if more U.S. tariffs spark a broad rise in the dollar, putting depreciation pressure on remaining emerging market pegs. The current juncture is a uniquely dangerous time for dollar pegs. Fear of Floating Exchange Rates in Emerging Markets_7

Fear of Floating Exchange Rates in Emerging Markets_7

Fear of Floating Exchange Rates in Emerging Markets_8

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UBS

Economic

The legendary American jazz virtuoso Keith Jarrett strides on to the stage, sits down at his piano and, once his audience has fallen silent, begins to play. Starting with just four notes – tentative, reluctantly, even – he gradually builds his performance, coaxing astounding melodies, harmonies and cadences from his instrument in a dazzling display of brilliance that puts the 1,400 onlookers in raptures.

It is January, 1975, late in the evening at an opera house in the German city of Cologne and the man widely regarded as one of the world’s greatest musical improvisers is making history. The recording of the “Köln Concert” – performed without rehearsal, preparation or notes – was to become the biggest-selling jazz piano album in history and an inspiration for music lovers worldwide.Now shift the setting, to a futuristic New York, and a timber, aluminium and glass office building dominates the skyline. It has sealed the reputations of its architects and structural engineers as a triumph of energy-efficient design and a paragon of the modern workplace. Its carbon emissions are award-winningly low.

What the gazing observers and excited critics don’t know, though, is that just months beforehand an overwrought project management team had been putting the finishing touches to their own carbon-mapping system in a bid to overcome the prevailing inadequacies of existing measures of projected CO2 emissions. Or that the entire air-conditioning had to be replaced – by a start-up whose eleventh-hour ceramic network was the only one that passed environmental muster. How did they do it? They worked with what they had; they improvised.

Shift the scene (and fast-forward time) again. To the outskirts of Paris and a busy suburban railway where trains stop mid-station to let passengers admire a thriving local nature reserve. The sanctuary sits next to a compact residential development with a burgeoning waiting list of wannabe tenants, keen to inhabit its wooden-clad eco-homes.

Yet, less than two years ago, construction was brought to a grinding halt on the discovery of a rare and protected breed of moth, whose habitat was directly in the proposed rail-link’s pathway. A skeptical new mayor worried about threats to the indigenous community abruptly threatened to pull funding. Financial backers, concerned to minimize their likely losses, were growing edgy.

Which brings us to the last shapeshift. In London (again, at a future date) a stressed risk manager sits with her head in her hands, having spent hours poring over the incomplete data that has made pricing a bond issue next to impossible.

Her firm wants to finance a new clean hydrogen plant in the north of England, whose worthy aims contain numerous likely pitfalls. The carbon capture technology proposed is nothing if not ambitious, costs are rising, demand remains unpredictable, and central government’s appetite to get behind the green venture seems to be waning. Does she agree a figure in the face of the unknowable, or refuse to sanction the funding and risk her employer’s standing?

Each of these scenarios could have resulted in entirely different outcomes – and, with our London risk manager, there may yet be more unforeseen surprises and it might still. In each case the protagonists have lofty ambitions, but they also find themselves operating in an imperfect world that is relentless in its propensity to catch them unawares. And, needless to say, with the exception of the case of Jarrett, each instance is set against the backdrop of the world’s overarching aim of reaching net-zero emissions by 2050 at the latest.

There are plenty of common threads. Carbon mapping the lifetime of a building, new or otherwise, can only be an incomplete science that relies on best-guess forecasts. Finding the best way to preserve our natural habitat, or work with an often underserved local community, remains a work in progress. Costs, impacts and the motions of the economic cycle around them are perilously hard to predict. Throw in a global pandemic and everyone’s figures will go awry.

In London, the risk expert debating whether to give the all-clear to her firm’s backing of a new renewable energy venture has a difficult task ahead. Green hydrogen is a potential base renewable fuel of the future; its technologies are moving rapidly but costs are high and there are also potential negative environmental effects.

Our manager has to balance the likely generous future revenue streams from the project – almost certainly in the near term underpinned by subsidy – against the potential risks to her firm of pressing ahead and lending the money. The available data will inevitably contain holes and there is yet to be a common universal standard for reporting them.

Her counterparts in these stories were there before her, and embraced the imperfect place in which they found themselves – and, like a true jazz musician, shifted and adapted their patterns along the way. Complex dynamic systems do not respond in linear ways; our tools, maps and plans will need to be thorough but also fluid.

In the case of Jarret’s majestic Cologne concert, the story behind the story makes his decision to play, and so brilliantly, all the more extraordinary. His piano was, in fact, to all intents and purposes broken – out of tune, with worn-out keypads and foot pedals that thudded and stuck.

He arrived in the city, for an 11.30pm performance that was the only one the venue could make available, exhausted. He had such bad back ache after a 500-mile car journey that he took having exchanged his airline tickets for cash that he had to wear a brace. He was also hungry after the restaurant he visited botched his order and brought his food just as he had to leave.

Undaunted, Jarrett turned the piano’s shortcomings into strengths, dwelling on the undamaged keys of its middle register and using the foot pedals’ dull thuds as an accompanying percussive beat. Faced with an imperfect world, he improvised, adapted and – ultimately – shone. Having backed ourselves into the arguably the mother of all evolutionary corners, investors and committed sustainability professionals could all learn a thing or two from such virtuosity and mastery. We have no choice but to play the proverbial broken piano!

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Risk Warnings and Disclaimers

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PIMCO

Economic

In amateur tennis, fully 80% of points scored are the result of an errant shot, such as hitting the ball out of bounds. This was the insight that Charles Ellis used to characterize investing in his classic “The Loser’s Game.” It is not what investors get right that defines success, it is what they do not get wrong.

While he was writing in 1975, this idea captures a lot of what happened to emerging market (EM) debt during the mid-2000s. Investors who were leaning into risk and trying to time the market around macro events started to play a loser’s game. The winner’s game, in contrast, shifted toward bottom-up trades that are uncorrelated to election cycles, geopolitical events, and other systemic macro events – areas where it has become more difficult to have an edge as an investor.

EM debt has become the largest pool of credit in the world, according to the Bank for International Settlements, surpassing the U.S. over the past decade. Along the way, many of EM’s fundamental attributes have been transformed. As the market has evolved, so too must investment strategies adapt.

The best countries or regions are generally not those being hyped as the next success stories. In contrast to conventional wisdom, EM often rewards investors who minimize losses rather than maximize gains, and who avoid concentrated positions in high-yielding countries. We believe EM debt should be used primarily as a diversification tool – rather than a source of seeking high returns – prioritizing lower-risk countries and senior debt structures.

EM debt has similar default and recovery rates to U.S. corporate debt but also more volatility, especially for lower-quality issuers. That’s one reason why we believe bottom-up relative-value analysis and portfolio construction are more important to EM today than top-down macro analysis. In addition, active management in EM debt has consistently outperformed passive investing, according to Morningstar data.

Rapid economic growth through the early 2000s masked many underlying complexities in EM, but growth has slowed. In this piece, we attempt to unmask the asset class, identifying universal features of EM and how they can help in achieving broader investment objectives.

Storytelling versus hypothesis testing

The optimistic stories told by EM investors for decades revolved around demographics, urbanization, a rising middle class, and GDP growth catching up to developed market (DM) levels. Today’s stories are more nuanced. Catch-up growth continues, but at a slower pace. Policymakers are better at business cycle stabilization, but there is greater political and geopolitical uncertainty than before.

These stories aren’t inaccurate, but they have not always mattered for investment returns. EM equities should have been the biggest beneficiary from stronger growth, for example, but fared worse than both DM equities and EM debt.

Here, rather than storytelling, we take a more scientific approach. The investment hypothesis for EM debt is as follows. It should be used primarily as a means to reduce concentrations to other domestic risks without sacrificing yield.

Investors should not treat EM as a space to hunt for high returns. It may sound counterintuitive, but the case for EM debt should not be anchored on spreads, yields, or some other valuation metric. It should be based primarily on diversification benefits, in our view.

Therefore, investors should consider taking a page from Warren Buffett’s book: prioritize lower-risk countries with reasonable valuations over high-risk countries with great valuations, and move to more senior parts of the capital structure (from equity to debt).

Of course, there are exceptions. But this is the top-level hypothesis that seems best supported by the data.

An anatomy of the asset class

The number of investable EM countries has more than doubled in the past 20 years. We now model about 200 individual macro risk factors (such as foreign exchange, rates, and spreads) across about 85 countries. Correlations across this matrix range from 0.8 to -0.7, according to data going back 20 years, calculated by PIMCO. So there is extreme diversity within the asset class.

Moreover, some factors are “risk-on” while others are “risk-off,” i.e., positively or negatively correlated to global systemic factors such as oil or equities. There are now about 12 sovereign bond issuers that have provided similar portfolio ballast during risk-off events over the past 15 years as U.S. Treasuries, the perceived ultimate risk-off asset. During this 15-year period, a basket of EM local bonds hedged to U.S. dollars (as gauged by 5-year swaps) generated higher returns than comparable U.S. Treasuries (also as gauged by 5-year swaps) and had a similar success rate in hedging equity drawdowns but less of a payout when drawdowns occurred.

This increase in the number of countries has been overshadowed by the rise in available instruments, which has grown nearly 20-fold (see Figure 1) in the past two decades. Investors can now disaggregate country-level macro risk factors into fine granularity.

Emerging Markets: The Biggest, Fastest Growing, and Arguably Least Understood Pool of Credit in the World_1

Emerging Markets: The Biggest, Fastest Growing, and Arguably Least Understood Pool of Credit in the World_2

Recovery values (and loss-given-default) are also nearly identical, at about 40%. However, there are three nuances to note.

Default probabilities for issuers rated CCC are higher for EM than for U.S. corporates. (Spreads are wider too, so we are not commenting on whether this cohort is relatively rich or cheap.) This is because the rules of the game can get rewritten for the lowest-quality EM issuers because of political upheaval, whereas U.S. corporate issuers rated CCC operate within a more defined system of stable rules and bankruptcy law.While the EM and U.S. corporate default data share a similar mean, the EM data has a wider standard deviation. Default events in EM have a wider range of outcomes.Workouts can take longer in EM. A U.S. corporate restructuring may take months to work through a court system. By contrast, it may take years to negotiate terms among international creditors, the International Monetary Fund, and other bilateral lenders. All else equal, this means that the present value of a nonperforming EM debt instrument undergoing a restructuring will be lower (even if the ultimate recovery value is the same).

Asymmetry of certain risks

There is an additional empirical nuance, perhaps the most important one of all: the mark-to-market efficiency of returns along the quality spectrum, as captured by metrics such as the Sharpe ratio, a gauge of risk-adjusted return. Similar to fundamental credit risk, measures of mark-to-market volatility increase much more on the lowest-quality bonds in EM than in U.S. corporate debt, rendering a lower Sharpe ratio for EM debt rated single B and CCC.

Drawdowns are also disproportionately deeper during times of acute stress for EM (see Figure 4). Worst of all, the sensitivity to market-based returns, or betas, becomes asymmetric, meaning the downside capture during a market sell-off is larger than the upside capture during a rally.

Emerging Markets: The Biggest, Fastest Growing, and Arguably Least Understood Pool of Credit in the World_3

None of this means that there cannot be compelling value in EM debt rated single B and CCC. But it does explain why too many investors have been seduced by the siren song of high-yielding, low quality frontier markets. The bonds may be cheap, but the efficiency of the resulting returns is poor for investors with anything short of a very long time horizon.

This explains why EM debt offers higher spreads compared with U.S. corporates despite similar fundamental credit risk – about 70 basis points on average on a risk-neutral basis over the past five years. The additional spread is not a sign of market inefficiency. It is compensation for other burdens, such as unfamiliarity (i.e., the need to explain newspaper headlines to one’s investment board), wider bid-ask spreads in secondary markets, and additional mark-to-market volatility, especially on lower-quality bonds. In theory, these additional burdens shouldn’t matter to long-term value investors. But in practice they do.

Investment approach

This siren song also explains why some investors say they’ve been on a roller coaster ride with EM in the past. Beyond general asset class volatility, many have been exposed to poor sizing of the asset class in their broader portfolio, and imprudent risk scaling within the EM debt allocation. Let’s look more closely at both.

Strategic asset allocation (sizing the beta)

If diversification is the main objective, then the correlation of EM debt to a broader portfolio is the most important metric. This is true for any asset class, but it is especially important for satellite exposures that play a more peripheral role in portfolio construction.

An asset inclusion test offers a clear framework. It reduces the decision whether to include an asset class to an optimization function: Maximize a portfolio’s Sharpe ratio subject to the constraints of risk, return, and correlations of the individual assets.

The result is a measure of each asset’s marginal impact on the portfolio’s overall Sharpe ratio. This will be fairly unique for each investor. But generally speaking, EM debt scores better than most other assets. It does so because of favorable correlation characteristics, not solely because of higher yields.

The correlation between EM debt and U.S. corporate debt is about 0.63 over the past 10 years, using J.P. Morgan data. This is relatively low within the world of fixed income spreads. And this is the point: EM debt must be assessed jointly by its risk, return, and diversification properties at the broader portfolio level, rather than narrowly on some rich/cheap valuation metric, and not independently from one’s overall portfolio.

Abiding by these guidelines leads to a more sober assessment of sizing in strategic asset allocations. Many clients, ranging from insurance companies to pension funds, typically have chosen an allocation of 2% to 8%.

Risk scaling (seeking alpha)

Investors are always at the mercy of what the market offers. If markets evolve, so too must investment strategies.

Consider how the EM debt market has evolved. In the early years (1990s and early 2000s), there were few countries in EM. Most issuers readily overpaid to access international capital. Growth was booming but punctuated by homegrown shocks (e.g., 1994 in Mexico and 1997 in Asia). The key skill set was top-down macro analysis. Investors could beat the market by leaning into risk and harnessing excess yields, while hopefully sidestepping country-specific sell-offs.

Today, there are far more countries and instruments to consider. Growth is middling and recent shocks are mainly exogenous and systemic (e.g., the 2008 global financial crisis, 2013 Treasury taper tantrum, and 2020 pandemic).

It is difficult to have an edge in macro analysis. Not only is it a more crowded field, but the nature of risk has shifted – from economic complexity, which can be modeled, toward political uncertainty, which can be impossible to predict.

In our opinion, the key skill set for investing in EM debt today is bottom-up relative-value analysis and portfolio construction. It is the ability to identify small arbitrage opportunities, instrument by instrument, and then combine and scale each in a way that a basket of these trades is more efficient than any one is independently.

Convexity – or the nonlinear relationship between prices and yields – is key. It embeds downside cushion during market sell-offs – prices fall but decreasingly so. This is particularly important given the excess volatility and asymmetric beta sensitivities noted earlier, especially at the lower end of the quality spectrum.

Of course, top-down macro analysis remains critical – but as a starting point. It must be thoroughly mapped to create space for the bottom-up alpha process to flourish. We model and measure 10–15 distinct bottom-up trade types and scale them in portfolios based on their Sharpe ratios and correlations to the beta. This is an engineering challenge, which leads to much more bounded results than if it were a forecasting challenge.

Playing a winner’s game

The tennis analogy mentioned earlier – winning by limiting errors – is not just a metaphor. It comes through clearly in the data. Consider the best and worst EM debt investors over the past decade (see Figure 5), and compare the journey, month-by-month, of each along the way. Did the best investors achieve their status by maximizing victories or by minimizing defeats? The answer is clear.

Emerging Markets: The Biggest, Fastest Growing, and Arguably Least Understood Pool of Credit in the World_4

The best and worst investors had about the same frequency of 1st-quartile monthly returns (23% versus 21%, respectively). But the best investors had a dramatically lower frequency of bad months. They experienced 4th-quartile monthly returns 21% of the time, versus 38% for the worst managers.

This is consistent with the asymmetric return profile of the asset class discussed earlier. The efficiency of returns from higher-quality countries can be overshadowed by the inefficiency of returns from lower-quality countries. Likewise, years of positive alpha, or market outperformance, can be wiped out in a single drawdown episode.

Our process is explicitly designed around these empirical realities for the asset class. It is designed to minimize the incidence of 4th-quartile monthly returns. (Please reach out to your PIMCO representative for statistics specific to PIMCO.)

What about passive investing? It has been remarkably consistent, ranking at the lower end of the 3rd quartile year after year (see Figure 6).

Emerging Markets: The Biggest, Fastest Growing, and Arguably Least Understood Pool of Credit in the World_5

The vast majority of active managers perform much better. Moreover, this better performance does not have to feel like a roller coaster.

Investors can treat EM debt as a structural allocation, used to de-concentrate from domestic sources of credit risk. They can size the allocation based on its effect on the Sharpe ratio of their overall portfolio. And, most importantly, investors should manage the EM allocation with caution. That can mean avoiding the temptation to migrate toward high-conviction, high-concentration positions in high-yielding countries, which can magnify macro-driven volatility. That game may have worked two decades ago. But it is a difficult game to win today.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Goldman Sachs

Economic

Stocks

Chinese stocks may be poised to climb again, even after gains from an immense rally in September faded. Recent Chinese policy announcements suggest the government is determined to support the stock market at the same time that the outlook for earnings growth is moderately improving, according to Goldman Sachs Research.

Some investors may be hesitant to chase returns after the whipsaw in stock prices, says Goldman Sachs Research’s Kinger Lau, chief China equity strategist. The last few recoveries in China’s equities were short-lived and weren’t accompanied by policy follow-through. But there are signs this cycle could be more enduring.

“History suggests this rally may have more legs, especially if policy pledges and earnings come through,” Lau says.

Why China’s Stock Market May be Poised for Further Gains_1

One of the main reasons Chinese equities may rally is that the government appears determined to have a significant impact — unveiling more than 10 key measures and papers since late September, spanning monetary and fiscal policy and property and equity markets.

China watchers may have suffered from “policy fatigue” in the past year, given that the delivery on policy promises has been perceived as underwhelming, Lau says. The policy announcements from late September may be different. They have not only positively surprised investors, but those efforts have changed the policy narrative.

“The magnitude, breadth, and comprehensiveness of this easing package is arguably the most significant in recent history,” Lau says. It may rival major support packages in the past, notably the A-share (stocks listed in mainland China) rescue plan in 2015. “Investors are getting what they have been hoping for, to a large extent,” he says.

Every RMB 1 trillion of fiscal stimulus that goes to the real economy (and not for debt repayment) should lift China’s real GDP growth by 40 basis points, which in turn would add 2 percentage points to the earnings growth of stocks in China’s main indexes, the MSCI China and the CSI300. The other factor that could also boost earnings is a moderate pickup in consumption demand.

As a result, our analysts raised their price-to-earnings targets, forecasting that MSCI China companies could trade at 12.0x earnings and CSI300 stocks could reach 14.2x earnings (up from 10.3x and 12.8x respectively). This pushes their new 12-month index forecast for the MSCI China to 84 and for the CSI300 to 4600, increases of 27% and 15%, respectively, from their previous 12-month targets. Goldman Sachs Research’s earnings growth forecasts are modestly below consensus for this year and next.

What if the announced policy moves fail to materialize and this market recovery turns out to be another head fake? Lau suggests that Chinese stocks — the second-largest equity market in the world — still have an important role to play for investors.

The recent historic rally shows that not trusting the policy moves can be costly, especially when valuations are low and investor holdings of the securities are light.

Chinese stocks are idiosyncratic and provide diversification benefits at a time when risky assets globally are becoming more synchronized.

Chinese retail and institutional investors might be on the cusp of a long-awaited shift from investing in property to equities.

Given persistent pressure on the housing market, equities may be a higher priority for the government in order to provide financing for the economy as well as a way for Chinese to invest and grow their wealth.

Chinese stocks are still trading at a valuation discount to other benchmarks. Lau says this shows that some investors remain reluctant to take risks based on long-term Chinese growth. However, he points out that recent indications of policy support should help reduce the risk of most severe downside scenarios, such as an economic hard landing or policy misstep, and therefore boost Chinese stocks.

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JPMorgan

Economic

If the U.S. economy were a pop star, it might be peak Taylor Swift. On nearly every major measure of economic health, the economy is in great shape and far ahead of its developed market peers. Real GDP is growing solidly, inflation is approaching the Fed’s 2% target and job growth has been robust even with a sub-4.5% unemployment rate for the last 3 years.

Yet people feel quite differently about the economy from how it’s objectively performing. Consumer confidence registered 98.7 in September, well below its 122-135 range prior to the pandemic and its peak of 145 in the summer of 2000. Why don’t Americans feel better?

Many households may not feel like they are doing as well as they should be given a strong economy

Low-income households typically have meager investment nest eggs—roughly 50% of households make below $50K in after-tax income1. As such, tremendous gains in equity investments and investment income over the last few years have disproportionately benefitted wealthier households.

However, real estate has been a boon for many Americans. U.S. homeownership is at 65%, the highest since 2011 (excl. pandemic distortions). As such, despite significant gains for the wealthy, the bottom 50% have still seen their net worth nearly double since the fourth quarter of 2019 (see chart).

Inflation is down, but sticker shock persists

Consumers don’t think in terms of year-over-year changes – they think in terms of price levels, after-tax income and the money left over after they’ve paid all their essential bills. After adjusting for inflation, low-income households (<$60K) got less goods and services for their buck from mid-2021 through mid-20232.

Food in particular has been a sore subject. Spending on off-premises food and beverage consumption has grown a cumulative 23% since mid-2020, but adjusting for inflation amounts to just 2% of real growth. Similar increases in essential goods and services (i.e. insurance, rent and interest) may explain why inflation uncertainty is still elevated for those making below $50K3.

Consumers are slowly getting their purchasing power back, low-income inflation-adjusted spending recently returned to mid-2021 levels, but it’s likely going to take more time and disinflation progress for sentiment to turn.

Keeping emotion out of investments

As we show in the Guide to the Markets, political affiliation can greatly influence views on the economy. Considering this year’s presidential election and the fragmentation of the news environment, it’s no wonder why consumers may feel quite differently amongst themselves.

Despite lackluster sentiment, Americans have not stopped spending. Consumption is expected to have grown at a solid 3% ann. pace in the third quarter, supporting continued earnings growth for U.S. companies. The economy is by no means perfect, but there are still plenty signals of healthy and improving fundamentals that should lift sentiment over time and contribute to continued investment gains. For investors, large divergences in economic perceptions also underscore the importance of keeping emotion out of investing, during and beyond political elections. With the Economy so Strong, Why Don’t Americans Feel Better?_1

With the Economy so Strong, Why Don’t Americans Feel Better?_1

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Central Bank

Forex

RBA policy to remain unchanged

The upcoming Reserve Bank of Australia (RBA) policy meeting on November 5 is highly anticipated, with the bank adopting a wait-and-see approach and holding the cash rate steady while monitoring economic developments. The focus will be on ensuring that inflation continues to decline and that the economy remains on a stable growth path, with potential rate cuts anticipated in early 2025 if conditions improve.

RBA in Wait-and-See Mode Despite Drop in Inflation_1

Inflation ticks down within target

Recent inflation figures show a mixed but overall encouraging pattern. In the September quarter, the headline inflation rate dropped to 2.8%, the lowest level in three and a half years. Significant drops in fuel and electricity prices, aided by government rebates, drove this decline. However, underlying inflation, measured by the trimmed mean, remains above the RBA’s target band at 3.5%. This persistent core inflation suggests that the RBA may need to maintain a cautious stance as service sector inflation, particularly in rents, insurance, and childcare, continues to exert upward pressure.

RBA in Wait-and-See Mode Despite Drop in Inflation_2

GDP and economic growth

The development of Australia’s GDP has been modest. The June quarter of 2024 saw a 0.2% q/q increase in economic growth, which is consistent with the ongoing trend of gradual but consistent expansion. The weakest annual growth since the early 1990s, with the exception of the pandemic period, was 1.5% in the 2023–24 fiscal year. Although government expenditure has provided some support, this lethargic growth is a result of subdued household consumption and a decline in discretionary spending.

Various factors, including international economic conditions, domestic inflation patterns, and labor market robustness, will influence the RBA’s decision. The recent decrease in headline inflation is promising; however, the RBA remains vigilant about the stickiness in underlying inflation and its possible effects on the economy. The GDP data underscore the necessity for ongoing support to foster economic growth and tackle the difficulties confronting households and companies.

Aussie stands near critical area

Investors will closely scrutinize the language and tone of the RBA’s statement, even though the immediate decision to hold rates might not cause significant movement. Investors will look for clues about future monetary policy direction, which will influence the Aussie’s trajectory in the coming months.

Aussie/dollar rebounded off the 0.6535 support level, which overlaps with the medium-term uptrend line, with the next strong resistance coming from the 200-day simple moving average (SMA) near 0.6620. However, a tumble beneath the diagonal line could open the way for a test of the bearish spike of 0.6360, achieved on August 5.

RBA in Wait-and-See Mode Despite Drop in Inflation_3

Source: XM

Risk Warnings and Disclaimers

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Justin

Political

Rural Georgians are voting early at a higher rate than those living in Democratic-leaning counties that were key to President Biden flipping the state blue in 2020, the most recent data show.

Of the state’s 159 counties, the top 23 for absentee and early in-person voter turnout were won by former President Donald Trump in 2020, according to the state's elections website.

That includes the rural counties of Towns, Oconee and Rabun – which have seen 69.06%, 65.51%, and 64.46% of their active voters already casting ballots, respectively.

Towns County voters outpaced the Georgia county average early turnout rate by roughly 15%, the Atlanta Journal-Constitution reported.

That includes suburban blue-leaning Cobb County and Gwinnett County, as well as the Democratic stronghold of Fulton County – home to Atlanta.

Of Fulton County’s active voters, 53.51% cast ballots before Election Day.

Georgia has smashed early voting records since early voting began on Oct. 15. On Wednesday evening, state officials announced that more than half of the state’s total active voters have already cast ballots.

Turnout in several rural areas that favored Trump is already close to total 2020 turnout, projections show.

Atlanta metro-area counties that voted for Biden are still significantly larger than rural areas with higher turnout, however.

Nearly 385,000 Fulton County voters cast early in-person ballots, followed by 275,207 from Gwinnett County and 271,426 from Cobb County.

By contrast, just under 7,000 Towns County residents voted in person during Georgia’s early voting period, which runs through Friday, Nov. 1.

Regardless, the spike in early voting in rural parts of Georgia could be a sign that Trump and Republicans have been successful in their efforts to gin up enthusiasm among their base.

It also could change perceptions of the way analysts and predictors interpret voter turnout – traditionally, early voting would heavily favor Democrats while an Election Day surge could help Republicans.

Dave Wasserman, of the nonpartisan Cook Political Report, noted on X that early turnout in some rural red Georgia counties was on track to match their total turnout, but said it was not necessarily an indicator of who would win.

"It's notable that a place like Towns Co. (Trump +61 in '20) is at 92% of its final '20 turnout, while Clayton Co. (Biden +71) is at 69% of its '20 turnout," he wrote on X.

"Doesn't tell us who will win GA, just that Dems have more work to do than Rs to turn out their vote in the final days."