Demonstrators briefly stop empty fuel trucks arriving to refill at a fuel distribution facility, as they protest the rise in fuel costs in Duque Caxias, Brazil, Monday, May 28, 2018. A strike by Brazilian truckers has caused shortages at gas stations and supermarkets across Latin America's biggest country. (AP Photo/Leo Correa)
A truckers’ strike in Brazil underscored the challenges facing EM government reforms © AP

Emerging markets suffered their biggest portfolio outflows in a year and a half in May, as foreign investors dumped EM assets in response to rising US interest rates and a strengthening US dollar.

Data from the Institute of International Finance, an industry association, show cross-border outflows of $12.3bn in the month, split roughly equally between EM bonds and equities.

May’s outflows added to a small outflow of $300m in April and followed accumulated inflows of $317bn during the previous 16 months. The most recent month of significant outflows was November 2016 after the election of Donald Trump to the US presidency, which itself followed a period of strong inflows.

The IIF said a combination of factors had been at work in May including funding pressures in Argentina and Turkey, a truckers’ strike in Brazil that underscored the challenges facing government reforms, renewed US tariff threats and retaliatory actions, and political uncertainty in Italy and Spain.

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But it added that, against a backdrop of higher US yields and a stronger dollar, there had been a broadening of outflows across the countries it surveyed, “suggesting that the risk-off environment is affecting a greater range of EM countries”.

The IIF’s data follow similar figures from EPFR, a company that monitors flows to mutual funds, exchange traded funds and others, which also showed significant outflows last month, including outflows from EM bond funds in the final week of May that were the biggest since the last week of 2016.

Many investors appear to have been taken by surprise in recent weeks, as the strength of the dollar and the rise in US Treasury yields exposed weaknesses that caused heavy selling of the Argentine peso, Turkish lira and other currencies. This was in spite of clear signalling by the US Federal Reserve of the upward path of US interest rates.

Urjit Patel, governor of India’s central bank, argued in the Financial Times this week that EM assets had been hit by a “double whammy” of predicted reductions in the Fed’s balance sheet as it unwinds its quantitative easing programme, and an unpredicted increase in the issuance of new Treasury bonds to fund the fiscal deficits resulting from the Trump administration’s tax breaks.

“Both scale and timing of the US fiscal deficit have been a surprise to markets,” he wrote, causing a crisis in dollar bond markets for emerging market issuers.

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Despite the outflows from portfolio assets, the IIF said broader capital flows to EMs excluding China, including foreign direct investment and other flows, remained positive, at an estimated $32bn in April, well above average flows of $7bn a month in 2017. It said in a note that the outlook for EM growth remained strong, led by a resilient Chinese economy, and that despite its recent appreciation the dollar had gained only about 1.5 per cent on a trade-weighted basis this year.

It added: “Much will depend on how the global trade landscape evolves, as an escalation in tensions could well boost demand for dollar-denominated assets.”

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