The outlook for emerging market debt (EMD) is two-sided, said INM IM in its las market analysis. On the one hand, the global liquidity environment remains benign, thanks to low developed-market bond yields and a limited risk of rising yields, particularly in Europe and Japan. On the other hand, EM endogenous factors remain weak, as growth continues to struggle and reforms are still unconvincing.
Global liquidity still very supportive
The liquidity environment for EMD has remained supportive in the past few months. Even in the past weeks, when US bond yields rose by around 40 basis points, the search for yield remained strong. Hard-currency debt (EMD HC) benefited, as did high yield credits in developed markets. “As US bond yields rose and market expectations for the first Fed rate hike moved from autumn to summer, hard-currency debt clearly outperformed local-currency debt. A lot of this outperformance can be explained by the rebound of the oil price since the last week of January, as EMD HC had suffered relatively strongly from the sharp drop in oil prices. But the deteriorating prospects for EM currencies have also played a role”, explained Jacco de Winter, senior financial editor at the Dutch firm.
EM growth momentum has deteriorated
Two things have changed in the past few weeks, said de Winter. Firstly, EM growth momentum has deteriorated sharply. “Our own EM growth momentum indicator has declined sharply in the past weeks, after being stable at the neutral mark for several months. Of the 18 markets in the index, only Thailand, Chile and Mexico have a positive growth momentum now. The other 15 are negative or neutral. The worst momentum can be found in China, Indonesia and Russia”.
Secondly, monetary easing in the emerging world has become more pronounced, with recent interest rate cuts by Indonesia and Turkey. Twelve of the main 16 emerging economies are now on an easing path. This is the result of weak growth and falling inflation, and because policy makers want weaker exchange rates to compensate for lower raw material prices and/or lost competitiveness. Lower raw material prices continue to put pressure on many emerging economies, particularly the fundamentally weak ones. “This explains why in the past weeks Nigeria stopped defending its currency and Azerbaijan decided to devalue its currency (by 33%!) for the first time since 1999”, stated ING IM expert.
Volatility in EM currencies has increased
“The combination of weaker growth and overconfident central banks is a bad one for EM currencies, which have become more and more volatile recently. The fear that we have had for years now – that EM exchange rates eventually will have to depreciate much more to fully reflect deteriorated EM fundamentals – is becoming more relevant”, argued de Winter.
Central banks should be more cautious
“In our view, EM central banks are counting too much on carry- trade-related hot money inflows. With the first Fed rate hike now only half a year away – this is what the Fed fund futures have priced in – countries like Turkey and Indonesia, with their high current account deficits and fragile domestic banking systems, should be more cautious. Especially since recent capital flows to the emerging world have already been weak”, afirmed ING in its analysis.
“Policy makers see no end to the growth slowdown. At the same time, inflation is declining. This probably makes them think that more currency depreciation is desirable, instead of a risk”, concluded.
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