Emerging Markets: Stirred, But Not Yet Shaken

0:05It'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 Alison Nathan, and this is Goldman Sachs Exchanges. Joining me here in London is Kamakshya Trivedi, Chief Foreign Exchange and Emerging Market Strategist in Goldman Sachs Research. Kamakshya, welcome back to the program. Thank you, Alison. 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.

0:41It 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.

1:20It'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 growthy tilt to that move.

2:05Assets that you would typically think underperform 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.

2:41I think you saw really 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 some to do with positioning, some to do with policy actions, you didn't quite see those hedges function in the way that people were expecting them to.

3:24And 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 is in 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. And 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?

3:56To what extent are policymakers 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 de-escalate 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.

4:38So 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 U.S.

5:17is on the right side of that. So a global risk of shock and the U.S. 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 unwound 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.

5:58Who 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. 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.

6:40Again, 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.

7:12But 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 higher energy prices, and down the road, potentially a 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.

7:55If 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 equities, for example, we're expecting something like 10 to 12 % upside from current levels.

8:35A 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 expect at this stage.

9:11And 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 somewhat more neutral positioning levels, I think should also be quite a big boost to those markets. We do, however, think it makes sense as you look at emerging markets broadly to balance some of those more digital AI exposures in places like Korea, like Taiwan, like 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.

9:55So 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, to once again consolidate and do better. And if we 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?

10:28Yeah, 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.

11:06We think that's one of the things that is going to persist and come back into play once this conflict de-escalates. 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.

11:41I 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 DM equities and U.S.

12:23equities. 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, Kamakshi, 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.

12:55This 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 and volatile time. Thank you, Alison. This episode of Goldman Sachs Exchanges was recorded on Thursday, March 12, 2026. I'm Alison Nathan. Thanks for listening.

13:49Kamakshya Trivedi:This material may contain forward-looking statements. Past performance is not indicative of future results. Neither Goldman Sachs nor any of its affiliates make any representations or warranties expressed or implied as to the accuracy or completeness of the statements or information contained herein, and disclaim any liability whatsoever for reliance on such information for any purpose. Each name of a third-party organization mentioned is the property of the company to which it relates, is used here strictly for informational and identification purposes only, and is not used to imply any ownership or license rights between any such company and Goldman Sachs.

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