De-escalation reinforces the case for emerging markets

The US-Iran framework deal announced on Sunday and the broader de-escalation that it offers reinforces a macro backdrop that should be positive for emerging markets (EM). We believe that if this agreement succeeds, the potential for lower geopolitical risk, softer oil prices, easing inflation pressures and a weaker USD provide a constructive environment for EM.

Asian markets reacted strongly to the news of a deal given that many countries are reliant on the Middle East for oil and gas supply.  Indeed, a potential sustained decline in oil prices should help bring headline inflation lower across many EM economies, giving central banks additional room to ease policy and improve domestic financial conditions.

In the past, lower energy prices have often acted as a positive terms-of-trade shock for net oil importers, supporting consumption, current accounts and corporate profitability across several EM regions.

Finally, a weakening USD should support EM assets. Historically, periods of USD softness have coincided with stronger EM equity and local currency performance, as external financing conditions improve and capital flows broaden beyond the US.

A sustained ceasefire may trigger a rotation

We continue to believe that this environment could trigger a rotation within EM equities. The energy sector, which outperformed during the recent geopolitical tensions, may give back some relative gains, while the materials sector could benefit from improved global growth expectations and a normalisation in commodity markets.

Precious metals are also worth watching. The sector lagged expectations since the conflict began, despite elevated geopolitical uncertainty. If markets shift focus from war risk toward lower rates, a weaker dollar and improving liquidity conditions, precious metals could begin to catch up.

Regionally, we see particular beneficiaries among net oil-importing markets, including parts of Asia, as well as in Europe, selectively. In South America, lower inflation and easier global financial conditions should also be supportive, especially where central banks could ease.

While the framework agreed between US and Iran is in its infancy, and risks remain, it offers a potential outlook of softer oil prices, declining inflation expectations, easier monetary conditions and a weaker USD. Together, these factors represent a compelling macro setup for EM.