Fears of rising U.S. interest rates spilled over into emerging markets, prompting investors to withdraw money from stocks and bonds to abruptly end what had been a multi-month streak of ‘influx.
A daily cross-border flow tracker prepared by the Institute of International Finance shows that foreign investment turned negative on emerging market equities at the end of last week and on debt this week, resulting in total daily outflows for the first time since October.
The turnaround comes as a sharp rise in borrowing costs in the United States, which has spread to many other major developed markets, rekindled fears of the “taper tantrum” of 2013, when the signal that the Reserve Federal government planning to withdraw its stimulus measures weighed heavily on the markets.
“The flows have turned negative and it’s really a surprise, as we were still at the start of the rebound after a 2020 cataclysmic,” said Robin Brooks, chief economist at IIR. “The honeymoon that began after the positive vaccine headlines in November is sadly over. We are in a rehearsal of the 2013 taper tantrum. ”
The IIR tracker uses daily data available for assets in 30 emerging economies. It showed total inflows of $ 20 billion in January, compared to over $ 50 billion in the more comprehensive but less topical monthly series of the IIR. Over the past week, the tracker recorded daily outflows of around $ 290 million, compared to daily inflows of around $ 325 million in February.
Emerging market assets typically offer higher returns than their developed market peers to offset the greater risk of holding them. When yields rise in developed markets, it taints their appeal.
The urgency of those concerns was on full display on Thursday, when Federal Reserve Chief Jay Powell refrained from suggesting that the world’s most influential central bank was ready to take action to tame the rate hike. of long-term interest. The US 10-year rate, a key marker for global rate markets, surged sharply as Powell spoke, rising above 1.6 percent on Friday from around 0.9 percent at the start of the year.
Wall Street investment bank Goldman Sachs said Thursday afternoon it expected the 10-year Treasury yield to rise further, to 1.9% by the end of the year. year, while increasing its projections for other developed market interest rates.
“What is literally changing as we speak is that a lot of investors are going, ‘oh my God, if US interest rates are going to go up, emerging markets are going to be bruised,” Brooks added.
“Ten days ago people thought that [talk of rising US rates] would be small potatoes for EM, but the pendulum has just swung.
Paul Mackel, global head of currency research at HSBC, echoed this view on Friday.
“We fear a tantrum for emerging currencies and the dramatic moves in US Treasuries are sure to cause negative fallout, especially for high yielding currencies,” he wrote to clients.
However, he added, the external balances and debt profiles of many emerging economies were in better shape today than in 2013. “This does not mean that emerging currencies should be fully immune now, but this helps to explain why the pressures for depreciation are not so intense. . . until there.”
Emerging market asset prices were also under pressure, with MSCI’s broad measure of emerging markets equities falling 7% in dollars from its peak less than a month ago. Debt tracked by JPMorgan’s Global EMBI Index was down nearly 4% from the end of last year when factoring in lower prices and interest payments.
Separate data from the EPFR research group, assembled by Barclays, highlights this shift in sentiment. Funds holding emerging bonds valued in major developed market currencies, such as the dollar, euro and yen, suffered the largest outflows since the end of March last year from the week to Wednesday. Barclays noted, however, that local currency bond funds posted stable inflows over the period, while equity funds continued to garner inflows.
“Sentiment towards EM risk in general remains intact, reflected in the fact that EM equity funds continue to attract inflows,” said Andreas Kolbe, Head of EM Credit Research at Barclays. But he noted that investors have become more savvy about which assets to target, with corporate bonds faring particularly badly due to the broader debt run-off.
“We believe that in the very short term, the risk is biased towards new exits,” he said on Friday in a note to clients of the British bank.
Bank of America analysts echoed this sentiment, saying, “We remain cautious [on] EM because we expect US rate volatility to remain high until the Fed adds some guidance ”.
Brooks, at the IIR, said he expected investors to continue withdrawing money from emerging market stocks and bonds in the coming weeks, unless the Fed focuses on l anchoring of long-term rates. Recent comments from members of the US central bank’s interest rate setting committee, suggesting that rising inflation was a natural consequence of the rebound from last year’s recession, have not been helpful, did he declare.
“The Fed’s goal should be to shift focus from the short term to the medium term, where the growth story remains murky,” he said.
Analysts have long warned that rising U.S. interest rates, coupled with any cuts to the Fed’s and other central bank bond buying programs that have fueled price hikes in global financial markets, would constitute a danger to emerging market assets. The push factor of low yields in advanced economies and the pull factor of potential currency appreciation in emerging markets would both be reversed, they say.
Brooks said that with few exceptions, emerging market currencies have already appreciated against the US dollar, “taking into account” the expected recovery of their economies as the pandemic recedes.
