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October inflows negative, but EM fixed income resilient

EM fixed income portfolio flows dropped sharply in October. However, EM equities saw almost the same amount in inflows. The mismatch can be explained by the various individual credit stories across EM, and there is no sign that the general EM rally will slow any time soon. Although a Fed hike is now almost certain for December, a renewed slowdown in China will have the most serious impact on EMs.

Nov 4, 2016 // 7:45AM

According to a research paper by the IIF, portfolio flows to EMs dropped US$0.2bn in October with US$5.6bn flowing out of EM fixed income, making it the asset class’s worst month since May.

However, this does not necessarily mean that the EM rally that has occurred over the past few months is slowing, nor that there is about to be a large selloff across the EM fixed income space.

“How EMs compare to each other is an important factor here. Although some may have performed poorly, at the same time Saudi Arabia was able to place US$17.5bn in bonds, much of it outside the Middle East – demonstrating that there is still substantial demand for certain parts of the asset class,” said a senior fixed income advisor.

They added that EMs have had a very positive last couple of months, and that any outflows were likely to be the result of the fact that although commodity prices have bottomed out, they have not risen, which has kept commodity-dependent nations under pressure – leading to outflows.

Venezuela and Mozambique are two such nations. The former’s 5-year government bond is yielding 31.067%, whilst the latter’s dollar-denominated government bond was yielding 23% towards the end of October – although these two nations are also plagued by other problems.

The variety in the susceptibility of EMs to different factors is evident when looking at Mexico. “The country has a wait and see attitude based on American political risk at present, but this is a one-off case,” the advisor noted.

Mexico’s peso has tracked the US election closely – which has led to substantial volatility. Over the last month alone, it has gained on the US dollar from 19.2859 to 18.5212, and then fallen back down to 19.3683 figures from Bloomberg show.

Political risk across EMs is also not necessarily external. “There is some political risk in the Philippines in part because of their president’s behaviour,” said the advisor.

They noted however that apart from US political risk and persistently low commodity prices, combined with the now almost certain expectation – of 80% – that the US Fed will hike rates in December, after keeping its benchmark interest rate on hold at 0.50% earlier this week, there is not much slowing the EM rally.

In addition, no one factor will be noticeably more dominant than any others if there was to be a slowdown in the EM rally. The same is true for any continuation or pick-up of the rally.

“Africa, for example, is very diverse. There is no new overall flow, but there are ‘chickenfeed amounts’ of credit emerging from different parts of the region.”

Although EM fixed income suffered in October, the IIF report showed that simultaneously, EM equities received US$5.4bn in inflows – almost the exact opposite to what EM fixed income lost in the same month.

“If anything, the sentiment has been shifting towards stronger growth in EMs. Risk factors in EMs have diminished from six months ago, and this could have encouraged more risk-taking on the equity side,” said the advisor, who added that it may actually demonstrate increased confidence in EMs – despite the fixed income outflows.

“Given that EMs are now not as entirely dependent on the advanced economies as they once were, most concern for the asset class has turned to revolve around China,” the advisor continued.

They concluded that the Chinese economy will eventually slow further. “This will affect East Asian flows because of the supply chain.”

Figures from Trading Economics, quoting the National Bureau of Statistics of China show that although the Chinese economy has expanded by 6.7% for the last three quarters, it is noticeably down from the 7.6% GDP growth recorded at the beginning of 2014.

Global Macro

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