May 6, 2021


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Rising interest rates chill torrid recovery in emerging markets

4 min read

The rush for emerging market assets from the depths of the coronavirus crisis a year ago faces its first serious test as rising US interest rates rekindle memories of the “taper tantrum” of 2013.

Emerging market equities have climbed nearly 90% in US dollars, from nadir in March to an all-time high last week, according to MSCI’s broad stock index in 27 countries. This surge is in part due to a fierce search for yield after central bank stimulus measures lowered developed market interest rates to historically low levels.

But a sharp decline in developed market government bond prices since early 2021 has pushed up borrowing costs and started to trickle down to emerging markets. MSCI’s emerging-equity barometer slipped about 5 percent from last week’s peak, reflecting declines in countries ranging from China to Turkey and Brazil.

“There is no doubt that the steepening of the yield curve around the world is starting to spill over into other asset markets and the last thing we need right now is a complete liquidation of the bond and equity markets.” said Win Thin, global head of foreign exchange strategy at Brown Brothers Harriman.

For some analysts, the setup this time around is similar to that of 2013, when investors fled emerging market assets as the US Federal Reserve signaled an end to the ultra-loose monetary policies that had given them such a blow. thumb.

Thin at BBH notes that the Fed will probably seek this time to reassure the markets that it will only slowly withdraw the extraordinary stimulus measures it deployed in the depths of the Covid-19 crisis.

However, some sectors are feeling the pressure. Chinese markets, which have been among the best performers due to the country’s rapid recovery from the coronavirus, fell over the past week.

The CSI 300 index of Chinese stocks is down about 6% in dollars from its February high, while the tech-driven Shenzhen ChiNext market is down 13%. Turkey, another large emerging country, has suffered a decline of around 8% since February 15, according to an MSCI index.

Meanwhile, Brazilian markets faced severe declines after Jair Bolsonaro, the right-wing populist president, sacked the boss of state-owned oil company Petrobras for failing to keep pump prices low.

Still, some analysts and investors say that expectations of a more favorable economic outlook in many countries will help mitigate the risk posed by rising global interest rates.

With vaccines in sight, says Tom Clarke, partner and portfolio manager at William Blair Investment Management, “you can discuss the number of quarters of lost or greatly reduced income, but that’s the kind of thing you can look at, even. if it’s a long way into the future. This caused a drastic shift in emerging market stocks and currencies. “

This, he says, is part of a more fundamental change. Before the pandemic, several factors weighed on emerging markets: protectionism in the United States and elsewhere, rising tensions between the United States and China, uncertainty over Brexit – all of which have been resolved, in a more or less.

“There have been concerns about a hard landing in China for several years and, lo and behold, it has generated positive growth, last year of all years,” Clarke said.

However, not all MEs will come out of the pandemic in such good shape. A crucial factor for their prospects will be their ability to make productive investments.

As recent FT analysis shows that foreign direct investment fell globally last year, but held up remarkably well across Asia. In China and India, it increased in 2020 by 4% and 13% respectively. In contrast, Africa and Latin America recorded the largest contractions of all regions for many components of FDI, including mergers and acquisitions, project finance, and investment in new facilities – the type that generates new jobs.

Line graph of% change in dollars showing growth potential has lifted India out of pandemic lows, while Brazil continues to weaken

Investors also praised domestic spending. Part of India’s response to the pandemic has been to increase public spending on infrastructure by 50% from its 10-year average. Brazil, where that investment has been cut for decades, has focused its response to the pandemic on consumer subsidies – popular in political terms but less good for growth.

Paul Korngiebel, emerging markets portfolio manager at Boston Partners, describes the coronavirus as “the massive distortion event that creates winners and losers in [country and] industrial sector as policy differs in response to Covid ”.

As in advanced economies, many emerging investors have focused on technology. In the past 12 months, shares of electric vehicle maker Tesla have risen 350% in New York City. Shares of Chinese rival Nio, also listed in New York, rose more than 1,000%.

Korngiebel is concerned that in some sectors investors have brought too much future growth into the present and that some valuations may be stretched. Conversely, he sees opportunities in sectors, like regional airlines, which have been crashed, as investors may have canceled them prematurely.

“We are really facing the aftershock of Covid right now,” he said. “It’s not over from an investor perspective – the pig in the python is only half digested.”

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