The stabilization of U.S. Treasury yields ahead of the Federal Reserve Open Market Committee meeting this week has brought some relief to emerging markets assets at large, even though concerns about the trajectory of U.S. Treasury yields and the recent outflows continue to dominate market sentiment. However, market watchers believe that the market backdrop is still conducive to risk-taking in emerging markets, with the rise in oil and commodity prices a supportive factor. Historically, there a clear positive correlation between EM fixed income returns and oil prices. This is true even on a total return basis, which naturally accounts for the adverse effects rising UST yields may have on EM fixed income returns in a risk-on/higher-commodity price environment. Analysts agree that the returns of EM fixed income assets over the past few weeks appear an outlier, suggesting some room for upside ahead. But higher oil prices are not a boon for everybody.
EM BOND FUND OUTFLOWS ACCELERATE
As the rise in U.S. Treasury yields continues to dominate market sentiment, outflows from emerging markets bond funds have accelerated, with both EM hard-currency and EM local-currency bond funds experiencing sizable outflows over the past week. However, flow momentum remains strong for emerging markets equity funds, led by inflows into Asia-focused funds. We note that the stabilization of U.S. Treasury yields over the past few trading sessions has brought some relief to EM assets, and we believe that the market backdrop is still conducive to risk-taking in emerging markets. In particular, the rise in oil and commodity prices should be a supportive factor as there is a clear, positive correlation between EM fixed income returns and oil prices historically; the mediocre returns of EM fixed income assets over the past few weeks therefore appear unusual, suggesting some room for upside ahead. This should also help to stabilize flows.
Andreas Kolbe, strategist, Barclays Capital, March 12
RELIEF RALLY LIFTS ALL BOATS
The lira exchange rate has rallied hard over the past couple of days as the market’s risk tone has generally improved. Thankfully, the rebound in risk appetite did not require a fresh collapse of U.S. Treasury yields – rather, it has occurred despite a gradual increase in yields, which is a much healthier position to be in. H owever, the lira’s rally had nothing to do with the Turkish Central Bank’s promise to hike rates further if required . This is clear when we examine the lira’s performance against peers, such as the South African rand, which are rallying equally hard: on a relative basis, the lira underperformed most of last year before enjoying a modest recovery after the change of CBRT governor; that outperformance has now fizzled away and underperformance has resumed. We have repeatedly written about how high inflation prints threaten the CBRT’s credibility afresh, especially in the eyes of President Erdogan, which we think is behind the renewed market skepticism and underperformance. The broader rally in EM FX does not change the fundamental risks for Turkish monetary policy and exchange rate.
–Tatha Ghose, strategist, Commerzbank, March 12