Highest net outflow in 17 years... When will the emerging market bond fund Exodus end?

Emerging market bond markets are in deep pain. According to the Financial Times (FT) on the 10th (local time), a whopping $50 billion has flowed out of emerging market bond funds this year. The problem is that the outflow of investment shows no sign of stopping for the time being. This is because advanced countries, including the United States, are raising interest rates rapidly to catch inflation (inflation).

The FT reported on the same day, citing data from JP Morgan, that “the net outflow from emerging market bond funds was the largest in 17 years, which is much higher than during the Chinese economic crisis in 2015.” “[The outflow]is happening very strongly,” said Marco Ruiser, Emerging Markets Portfolio Manager at William Blair. It has brought the perfect storm to the market,” he pointed out.

Emerging market government bonds are classified as high-risk assets compared to developed country bonds. Beginning in 2022, the U.S. central bank, the Federal Reserve (Fed), turned to tightening monetary policy. Emerging market bond markets also contracted sharply as preference for risky assets decreased due to austerity measures. JP Morgan’s EMBI Global Diversified Index, which tracks assets such as dollar-denominated government bonds in emerging markets, has fallen 18.6% this year.

Emerging markets have already been struggling with financial difficulties after COVID-19. Meanwhile, the move by the US Federal Reserve (Fed) to raise interest rates has taken a bigger hit. As US Treasury yields rose, emerging market bonds became less attractive. “Some investors are also concerned that US monetary policy tightening and increased economic pressure in other large markets, such as Germany and Italy, have increased the risk of a broader downturn,” the FT said.

However, the rise in raw material prices due to the Ukraine war took a toll on Turkey, which has a high proportion of raw material imports. Above all, since commodities are priced in dollars, the weakness of currencies against the dollar in emerging market countries has put additional cost pressures on them.

“Emerging market-related assets are highly correlated with economic cycles,” said Christian Maggio, head of strategy for emerging markets at TD Securities.

In addition, with the US employment data showing better-than-expected results, there is a growing possibility that the Fed will push ahead with more stringent austerity measures. The yield on the 10-year U.S. Treasury bond, which fell on fears of an economic downturn in the market, has risen since the announcement of the employment data. The U.S. Department of Labor reported last week that nonfarm payroll employment rose to 372,000 in June, far exceeding the consensus estimate of 250,000. Still, robust employment data provides the basis for the Fed to raise interest rates over recession fears and concerns.

The market is now paying attention to the US Consumer Price Index (CPI) for June, which will be released on the 13th. A higher-than-expected inflation could further stimulate the Fed, which could further strengthen the dollar. “The U.S. economy is performing relatively well compared to other major economies, and the Fed is also more hawkish, with the dollar index expected to rise 2% over the coming years,” said Jonas Galterman, senior economist at Capital Economics (CE), Dow Jones. analyzed.

A further appreciation of the dollar is likely to put further pressure on emerging market asset markets. Experts are diagnosing that while the Fed’s hawkish move continues, the emerging market investment exodus is likely to proceed further within this year.

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