Emerging market equities experienced a pause in their recent rally, largely due to the escalation of Middle East conflict pushing Brent crude oil prices above $100 per barrel for the first time since early 2022. This surge in oil prices is creating concerns about inflation and the economic outlook for various emerging economies, prompting investors to reassess risk.
The rise in oil prices is attributed to continued tensions in the Middle East, exacerbated by Iran's Assembly of Experts electing Mojtaba Khamenei, the late Supreme Leader’s son, as his successor. Mojtaba Khamenei's ties to the Islamic Revolutionary Guard Corps (IRGC) and his lack of prior government experience have led to predictions of further escalation rather than de-escalation in the region, with Iran continuing to target energy infrastructure and water desalination plants.
Despite the broader slowdown, earlier in the week, emerging market equities had seen a significant rally. MSCI’s gauge for developing-nation equities climbed 1.7% to its highest level since June 25, driven by optimism surrounding new AI models boosting heavyweight tech stocks. South Korea’s benchmark Kospi index jumped almost 5%. An index for EM currencies also advanced by 0.2%, extending its weekly winning streak to 11 sessions, the longest since 2007. However, the sustained increase in oil prices has dampened this optimism, with assets that had outperformed year-to-date, particularly emerging market equities (excluding China) and EM local currency bonds, experiencing sharp pullbacks.
Several countries are taking measures to mitigate the impact of rising oil prices. G7 countries are preparing to release strategic petroleum reserves, with Japan and South Korea also likely to draw down stockpiles. South Korea, for instance, secured over 8 million additional barrels of Middle Eastern crude through emergency measures. However, analysts note that the key pressure point isn't just crude prices but also the cost of refined products like gasoline, diesel, and critical inputs like fertilizer, which have more direct pass-through to consumers and supply chains. While some emerging markets like Brazil, a commodity exporter, might be relatively insulated, others like Turkey and Egypt have seen significant capital outflows from carry trades.
