Emerging markets suffer worst sell-off in decades

Emerging market bonds are suffering their biggest losses in nearly three decades, hurt by rising global interest rates, slowing growth and the war in Ukraine.

U.S. dollar-denominated emerging market benchmarks sovereign bondsJPMorgan’s EMBI Global Diversified total return so far in 2022 is about negative 15%, its worst start since 1994. A broad rally in global markets in recent days has only eased losses slightly, ending a seven-week losing streak for Wall Street stocks.

Nearly $36 billion has flowed out Emerging Markets According to EPFR data, mutual and exchange-traded bond funds since the beginning of the year; stock market flows have also reversed since the beginning of the month.

Brett Diment, global head of emerging markets debt at Abrdn, said: “This was without a doubt the worst start for the entire asset class in my memory, having been in the emerging markets business for over 25 years.”

Weekly bar chart of inflows/outflows into EM mutual funds and ETFs (billions of dollars) showing fund managers selling EM debt

Developing economies have been hit hard by the coronavirus pandemic, straining public finances. Rising inflation, slowing global growth and geopolitical and financial disruptions caused by Russia’s war in Ukraine have added to the economic pressures they face. Investment outflows threaten to exacerbate their plight by tightening liquidity.

David Hauner, head of emerging markets strategy and economics for global research at Bank of America, said he expects things to get worse.

“It is important that we have global inflation so high that monetary policymakers continue to be surprised by how high inflation is,” he said. “That means more monetary tightening and central banks will continue until something goes wrong with the economy or the market.”

Yerlan Syzdykov, global head of emerging markets at Amundi, said higher yields in developed markets such as the U.S., driven by central bank rate hikes, made emerging market bonds less attractive. “In the best case you will make zero, in the worst case you will lose money [this year],” He says.

Rate hikes in major developed market economies, if accompanied by economic growth, are not necessarily bad for emerging market assets, Hauner said. “But that’s not the case right now – we have serious stagflation and central banks are raising interest rates to curb rampant inflation in places like the US. It’s a very unhealthy backdrop for emerging markets.”

As the world’s largest emerging market, China has faced some of the heaviest sell-offs.

The economic slowdown has fueled concerns about geopolitical risks, including the possibility of China invading Taiwan following Russia’s invasion of Ukraine, as the government imposes draconian lockdowns to achieve its zero-coronavirus policy, economist Jonathan Foton said. Fortun) said. The Institute of International Finance, which monitors cross-border investment portfolio flows to emerging markets.

A bar chart of JPMorgan's EMBI Global Diversified Index, total return for the year to May 25, shows emerging market debt is off to its worst start to the year as a percentage in nearly three decades

He noted that Chinese assets have received a large number of so-called passive inflows over the past two years after China was included in global indexes, meaning that fund managers trying to reflect their benchmarks automatically bought Chinese stocks and bonds.

In March and April of this year, however, more than $13 billion in outflows from Chinese bonds and more than $5 billion from Chinese stocks.

“We expect negative outflows from China for the rest of the year,” Fortun said. “It’s a big deal.”

Fund managers did not allocate some of the withdrawals from China to other emerging-market assets, he said, leading to a general retreat: “Everyone is moving from the entire emerging-markets complex as an asset class to safer assets.”

The shock to commodity prices caused by the war in Ukraine has increased pressure on many developing countries that rely on imports to meet their food and energy needs.

But it also produced some winners for commodity exporters. While local currency bonds in the JPMorgan GBI-EM index have posted a negative 10% year-to-date total return in U.S. dollar terms, Abrdn’s Diment noted that there is wide variation across countries.

Bonds issued by Hungary, which is close to war and depends on Russian energy imports, have fallen 18% so far this year. Brazil, a top exporter of industrial and food commodities, rose 16% in dollar terms.

Valuations for emerging market debt “arguably look pretty attractive right now” and Abrdn has seen net inflows to its emerging market debt fund so far this year, Diment said.

However, Bank of America’s Hauner believes the bottom will only be reached when the central bank shifts its focus from fighting inflation to boosting growth. “It could happen sometime in the fall, but it feels like we’re not there yet,” he said.

Syzdykov said it depends on whether the inflation surge subsides and the global economy returns to a balance between low inflation and low interest rates. The alternative, he warned, is a U.S. recession next year, adding to the drag on global growth and pushing up yields in emerging markets.