2018 has been a difficult year for many emerging markets, but sentiment has recently shifted more positive in many cases, reflecting cheap valuations, a dovish Fed, and a China-US trade “truce.” With sentiment more positive, market focus is squarely on positioning, with people asking how much positioning was cut during the EM sell-off. We develop new data that give a comprehensive look at EM positioning, combining IIF work on capital flows with valuation changes on the stock, where the latter historically account for the bulk of positioning changes.

Equity market volte-face highlights renewed concern about U.S.-China trade tensions; Pace of decline in global central bank asset purchases accelerates; High debt-to-cash levels in the corporate sector—another sign of trouble for credit markets; Carry trade returns still generally sub-par, but looking more attractive for a few emerging markets

This year’s EM sell-off underscored the importance of FX valuation with markets, in dramatic fashion, going after meaningful FX overvaluations. At this point, our models signal neutral or cheap valuations for much of EM, so that currency misalignments are less of a risk factor as we approach 2019. But a positioning overhang in emerging markets remains a material risk factor, given the intensity of capital flows to EM resulting from G-3 monetary stimulus. This piece starts a series of Global Macro Views on EM flows and positioning, which we kick off today by looking at flows over the EM sell-off this summer.

Euro periphery current account balances have almost all swung into surplus, which is often cited as positive evidence that competitiveness has been restored. But the swing from current account deficit to surplus has a cyclical component, reflecting depressed import volumes due to still large output gaps in some cases. We estimate cyclically-adjusted balances for a range of output gap estimates. Adjusting for slack, Euro periphery current accounts are likely still in deficit.

Looking across the countries we cover in our Global Debt Monitor, non-financial corporate debt is at a record high of $75 trillion—up by $16 trillion since the 2013 taper tantrum.

The Euro zone current account balance is in sizeable surplus, which some see as a sign the Euro is undervalued and needs to rise. But the headline surplus in part reflects persistently large output gaps, which may be inflating the external balance by depressing import volumes. We derive a cyclically-adjusted current account balance for the Euro zone, which turns out to be negative, potentially signaling Euro overvaluation.
 

Estimates for Euro periphery output gaps are oddly small, even where real GDP has fallen substantially in the last 10 years. These estimates implicitly assume lots of activity is permanently lost, with potential “bending” down, almost as if to validate low actual GDP. The reality is that economic slack on the periphery is likely still sizeable, and holding down underlying inflation despite unprecedented ECB easing.