EM outflows could be disruptive for markets: IIF
The Institute of International Finance warns that this is likely to happen unless the Federal Reserve Board acts to underpin the US bond market
London
THE surge in US bond yields has precipitated large capital and money outflows from emerging markets (EMs).
Indeed, the Institute of International Finance (IIF) fears that unless the US Federal Reserve Board acts to underpin the US bond market, EM outflows could be disruptive for local and global markets.
"The scale of outflows is approaching those seen at the peak of the 2013 taper tantrum," said Robin Brooks, the managing director of IIF. "A change in Fed rhetoric is needed to help calm (participants from) the rise in US yields." He is concerned that "the violence of the rise in US longer-term rates" will encourage further sizable outflows from EMs.
Back in 2013, the "taper tantrum" - the surge in medium and long term bond yields - ended when the Fed changed its rhetoric. It issued a dovish statement that it would maintain accommodative financial conditions.
The outflows during the past fortnight, contrast with inflows of US$52.5 billion in January this year and US$31.2 billion in February.
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Only 26 per cent of the February total inflow was in equities and 93 per cent was invested in China. The remainder went into high yielding Chinese and other EM bonds.
Despite worries about Covid, foreign investors placed US$313 billion into EM securities last year, compared with US$360 billion in 2019, according to estimates by the IIF.
The key now is the trend of interest rates as yields on US 10-year Treasury bonds have increased from a low point of only 0.51 per cent last August to 1.62 per cent.
In the past few months, investment banks have recommended high yielding EM bonds. Their yields have also risen as the global bond market tends to follow the US.
Examples of current 10-year sovereign bond yields are China (3.3 per cent), Indonesia (6.8 per cent), the Philippines (4.5 per cent), Malaysia (3,3 per cent), India (6.2 per cent), Russia (6.8 per cent), Brazil (8.3 per cent) and South Africa (9.3 per cent).
Foreign investors incur currency depreciation risks when they invest in high yielding EM sovereign and other debt.
According to a recent poll conducted by Reuters, foreign investors who were previously bullish in the past few months have now become negative about EM currencies. They have cut positions in the Chinese yuan and have been selling several other Asian currencies.
Rising treasury yields tend to bolster the US dollar. US President Joe Biden's US$1.9 trillion stimulus following a US$900 billion stimulus towards the end of last year is expected to stoke an inflationary recovery.
Under those circumstances, bond yields can rise and bond prices could fall.
"Global financial conditions turned less favourable for emerging market economies in 2021," said the Bank For International Settlements in its latest quarterly report.
It added: "As the US dollar bounced back from its post-election slide in January, currencies of emerging market economies depreciated more."
The danger, according to the IIF, is that total EM debt reached US$77.7 trillion at the end of last year and US$3.98 trillion was denominated in US dollar debt.
Including the euro and the yen, total foreign exchange borrowing was marginally under US$5 trillion at the end of September 2020.
If these currencies appreciate, governments and businesses require more local currency to pay interest and repay capital.
READ MORE: Bond market's 'game of chicken' with Fed is set for a reckoning
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