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Is the emerging market rebound set to bounce back?

Emerging markets have reacted well to dovish signals from the US Federal Reserve. The rise in commodity prices has also contributed to their performance. However future interest rate increases combined with a slowdown in the rise in commodity prices could end the rebound.

Apr 6, 2016 // 8:16AM

The performance of emerging markets has seen a slight rebound since a recently delivered speech by Chair of the Board of Governors of the US Federal Reserve Janet Yellen suggested US interest rate rises would be fewer and farther between.

Two of the best performers in the near future will be Brazil and Indonesia according to Regis Chatellier, Senior Emerging Market Credit Strategist at Societe Generale.

“Indonesia has been improving its credit fundamentals, whilst Brazil is unlikely to default in the short term and has large reserves and low external debt,” he said, adding that the carry on Brazilian debt is still attractive.

A lower valued dollar has provided a boost to the emerging market fixed income sector. “There is less pressure on treasuries, and dollar bonds are doing better,” said Chatellier.

He added that there is no significant risk of default by any emerging market apart from Venezuela; much of the risk in emerging markets has been transferred from currencies to bonds.

“Emerging markets used to use their reserves to support their currencies. Increasing numbers of currencies are now floating, which has lowered the risk to foreign reserves,” he noted.

However, while floating a currency protects a country’s foreign reserves, it also tends to make those currencies more volatile.

The price of commodities also has a significant impact on emerging market performance. “Historically, spreads in the market have been tighter, and although they could tighten further, for any significant changes commodities would need to make a large rebound,” Chatellier stated.

The correlation between commodity prices and the performance of developing economies is very strong. The majority of emerging markets still need higher commodity prices, but there is still pressure on the balance of payments in many emerging markets, with the exception of those in Europe.

However, the rise in commodity prices is slowing. “As a result we will see the end of the emerging market rally within 1 or 2 months,” said Chatellier.    

Future interest rate rises by the US Federal Reserve is also likely to impact on the emerging market rebound. 

“The second half of the year will be more complicated. Although the emerging market rally has been impressive, growth remains sluggish and there has been no real improvement in emerging market fundamentals, which are unlikely to progress further,” noted Chatellier.

Venezuela and Turkey are likely to encounter large problems in the future. Venezuela has a large debt repayment at the end of the year which if it doesn’t make could lead to default, and Turkey could prove problematic in the long run, as it already runs a large current account deficit and is strained by the geopolitical issues endemic to the region.

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