Fears over rising US interest rates have spilt into emerging markets, prompting investors to pull money from stocks and bonds in an abrupt end to what had been a months-long streak of inflows.
A daily tracker of cross-border flows prepared by the Institute of International Finance shows that foreign investment turned negative in emerging market equities at the end of last week and in debt this week, resulting in total daily outflows for the first time since October.
The turnround comes as a sharp rise in US borrowing costs, which has spread to many other large developed markets, has brought back fears of the 2013 “taper tantrum”, when the signal that the Federal Reserve was considering withdrawing its stimulus weighed heavily on emerging markets.
“Flows have turned negative and that’s really a surprise, as we were still early on in the rebound from a cataclysmic 2020,” said Robin Brooks, the IIF’s chief economist. “The honeymoon that began after positive vaccine headlines in November is unfortunately over. We are in a repeat of the 2013 taper tantrum.”
The IIF’s tracker uses daily data available for assets in 30 emerging economies. It showed total inflows of $20bn in January, compared with more than $50bn in the IIF’s more comprehensive but less timely monthly series. Over the past week, the tracker recorded daily outflows of about $290m, compared with daily inflows of about $325m in February.
Emerging market assets typically offer higher returns than their developed market peers to compensate for the greater perceived risk of holding them. When yields rise in developed markets, that dents their allure.
The urgency of those concerns was on full display on Thursday, when Federal Reserve chief Jay Powell refrained from even hinting that the world’s most influential central bank was prepared to take action to tame rising long-term interest rates. The US 10-year yield, a key marker for global rates markets, jumped sharply as he spoke, stretching above 1.6 per cent on Friday from about 0.9 per cent at the start of the year.
Wall Street investment bank Goldman Sachs on Thursday afternoon said it expects the 10-year Treasury yield to rise further, to 1.9 per cent by the end of the year, while it also increased its projections for other developed-market interest rates.
“What is changing literally as we speak is that many investors are going ‘oh my gosh, if US interest rates need to go up, emerging markets are in for a bruising’,” Brooks added.
“Ten days ago people were of the mindset 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 that view on Friday. “We have feared a tantrum for EM currencies and the dramatic moves in US Treasuries are certainly causing negative spillovers, especially for the 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 EM FX should be fully immune now but it does help to explain why depreciation pressures are not as intense . . . so far.”
Prices for emerging market assets have also been under pressure, with MSCI’s broad gauge of emerging market equities down 7 per cent in dollar terms from its high less than one month ago. Debt tracked by JPMorgan’s global EMBI index has generated a loss of almost 4 per cent from the end of last year when accounting for a price decline and interest payments.
Separate data from research group EPFR, collated by Barclays, highlight this change in sentiment. Funds holding EM bonds priced in leading developed market currencies, such as the dollar, euro and yen, endured the biggest outflows since the end of March last year in the week to Wednesday. Barclays noted, however, local currency bond funds had flat flows over the period, while equity funds continued to garner inflows.
“The sentiment towards EM risk in general remains intact, reflected by EM equity funds continuing to attract inflows,” said Andreas Kolbe, head of EM credit research at Barclays. But he noted that investors have become more discerning in which assets to target, with corporate bonds faring particularly poorly thanks to the broader debt sell-off.
“We believe that in the very near term, the risk is skewed to further outflows,” he said in a note to the UK bank’s clients on Friday.
Bank of America analysts echoed this sentiment, saying “we remain cautious [on] EM as we expect volatility in US rates to remain high until the Fed adds some guidance”.
Brooks at the IIF said he expected investors to continue withdrawing money from EM stocks and bonds in the coming weeks unless the Fed focused on anchoring long-term rates. Recent comments by 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, were unhelpful, he said.
“The Fed’s objective should be to focus attention away from the short term and on to the medium term, where the growth story remains murky,” he said.
Analysts have long warned that rising US interest rates, coupled with any reduction in bond-buying programmes by the Fed and other central banks that have fuelled rising prices on global financial markets, would spell danger for 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, EM currencies had already appreciated against the US dollar, “pricing in” the boost to their economies expected as the pandemic recedes.
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