FOREIGN flows into emerging market (EM) stocks and bonds excluding China have slowed sharply, as concerns grow over the United States Federal Reserve’s (Fed) impending tightening cycle and the emergence of the Omicron coronavirus variant.
According to the International Institute of Finance (IIF), EM investors have turned more selective and risk sensitive given the risks involved.
Moreover, surging inflation is forcing the hand of policy makers across the EM landscape, it says, noting 12 of 20 major EM central banks have tightened monetary policy since May.
Consequently, EM bond flows have started to diminish, the IIF says.
Data from the association of financial services industry show non-resident flows to EM assets excluding China decreased to US$6.3bil (RM26.5bil) last month, compared with US$11.3bil (RM47.6bil) in the preceding month.
Of the amount in November, EMs debt ex-China attracted US$2.1bil (RM8.8bil) in inflows, a significant decline from US$13.9bil (RM58.6bil) in October; while EMs equities ex-China saw inflows of US$4.2bil (RM17.7bil), compared with an outflow of US$2.5bil (RM10.5bil) in October.
“We see non-China EM in a de facto sudden stop, with the large devaluation of Turkish lira likely to worsen the picture going forward, given that contagion to the rest of EMs is possible,” the IIF says in its recent report.
“Underlying this overall picture is a lot of differentiation across individual emerging markets.
“The latest variant of Covid, an acceleration of Fed tapering and large devaluation in Turkey carry additional risks for an already stressed EM flows picture,” it adds.
Besides Turkey, Argentina and Brazil are among the most vulnerable in this regard.
The IIF notes China flows carry a large weight, hence it separates the country’s data from the rest of EM, so as to get a clearer view of any potential trend emerging from the economies.
Last month, China debt flows totalled US$4.2bil (RM17.7bil), compared with US$4.8bil (RM20.2bil) in the preceding month, while China equities saw inflows of US$5bil (RM21.1), compared with US$7.3bil (RM30.8bil).
While there could be volatilities ahead, the IIF notes that EMs has thus far averted a repeat of the 2013 Taper Tantrum, whereby there was a huge outflow of capital from EM stocks and bond after the Fed turned hawkish, sending US yields soaring.
The broad-based outflows from EM assets resulted in the sharp depreciation of EM currencies.
According to the IIF, there are primarily two reasons that have helped avert a repeat of the 2013 taper tantrum.
“First, the Fed learnt critical lessons from the taper tantrum and avoided the kind of hawkish shift that drove yields up in 2013.
Second, Covid variants continue to weigh on activity, so that recovery from the pandemic has been slower than markets expected, which has weighed on longer-term yields,” it explains.
Weak appetite
In Malaysia, foreign buying of local equities had also slowed significantly, falling to RM200mil last month from RM1.6bil a month earlier, according to data compiled by Maybank Investment Bank Research.
Meanwhile, foreign net inflows to Malaysian bond accelerated to RM2.9bil in October from RM600mil in the preceding month. Data for November have yet to be released.
Analysts note risk appetite towards EM, which is already rather weak, will likely be constrained further by a tightening of US monetary conditions. This poses a risk to capital flows to EMs.
Fed chairman Jerome Powell at the end of last month said he and fellow policymakers would consider a faster wind-down to the Fed’s bond-buying programme, Reuters reported.
The move is widely seen as opening the door to earlier interest rates hikes.
The Fed last month started reducing its purchases of US treasuries and mortgage-backed securities from US$120bil (RM506bil) a month at a pace that would put it on track to end purchases by mid-2022.
The stimulus programme was introduced in early 2020 to support the US economy weakened by the measures to contain Covid-19.
Nevertheless, Franklin Templeton is optimistic that EMs debt as an asset class is in a stronger position to weather the tightening of US monetary policy in 2022, compared to the case in 2013.
“We observe several fundamental and technical differences compared to 2013 that contribute to this relative resilience.
“They include improved balance of payments dynamics in EMs and a reduced reliance on external sources of finance; less vulnerable technical positioning within EM bond markets, including via lower share of foreigner participation; and a relative reduction in EMs corporate leverage,” the fund manager says in a note.
While it acknowledges that the relative global growth environment is not necessarily as favourable for EMs as it was back in 2013–2014, EM central banks have learnt valuable lessons, following the experience of the 2013 taper tantrum.
Hence, they are likely more prepared for the expected turbulence ahead.
“In our assessment, the swift and prudent monetary policy action in EMs that preceded the most recent taper announcement bodes well for EM debt markets,” Franklin Templeton says.
It notes that in 2021, the majority of EM central banks have simultaneously tightened policy in advance of the announcement of the taper of Fed asset purchases.
Conversely, in 2013, monetary policy tightening by EM central banks trailed the taper announcement and market reaction.