- Lower interest rates in developed markets helped support returns in emerging market debt in second quarter 2019
- Emerging market currency returns remained subdued as the USD was stable
- The outlook for emerging market debt will depend on global factors: growth, trade and geopolitical risks
Emerging market debt attracts strong flows
Emerging Market (EM) fixed income attracted more than USD 45 billion1 for the first half of 2019.
Can the strong investor interest continue?
USD 45 billion
inflows to emerging market debt
Central bank dovishness is not enough; a trade resolution is needed
EM debt asset prices rallied on the back of developed market central bank announcements to ease monetary policies as required to support economic activity and lift inflation and inflation expectations going forward. Such dovishness had a very powerful positive impact on risk appetite, favoring emerging market assets in all its forms and is likely to provide a cushion to emerging market assets for the remainder of the year.
However, dovishness in central bank policies (of developed market) is a necessary but not a sufficient condition to for EM economies to thrive and for EM asset prices to deliver strong returns.
For EM economies to deliver higher and sustainable growth - a basic requirement for solid and sustainable returns - global trade volumes and commodity prices have to recover in a sustainable fashion. For that to happen, #tradewars have to subside and global growth has to stabilize.
Absent a resolution to the ongoing trade wars, dovish monetary policies will only be able to carry the world economy so far for so long.
As expected, there was no resolution to the trade impasse between the US and China at the G20 meeting. However, the outcome was on the positive side as Presidents Trump and Xi agreed to re-engage in negotiations and delayed any further actions on tariffs.
Local currency debt: a carry environment
The outlook for local currency debt in 3Q 2019 is uncertain given a number of significant tension points -- trade, global growth, political risks, and monetary policy. However, lower US policy rates and potential weakening of the USD against EUR and JPY is conducive to carry.
Following a period of volatility in May, APAC currencies have partially recovered and the CNY stopped depreciating. However, the potential trade war escalation after the G20, or even a fragile truce, is negative for the region highly dependent on trade flows. We see gradual depreciation of the CNY due to slower growth and capital outflows, dragging down all regional currencies.
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