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 Alison Nathan, and this is Goldman Sachs Exchanges. Joining me here in London is Kamakse Trevedi, Chief Foreign Exchange and Emerging Markets Strategist in Goldman Sachs Research. Kamakse, 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. 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 ther

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

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 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? To 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

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