Free marketing & business support,
exclusively for UK financial advisers

Curtains for emerging markets?

May 2018

Emerging markets currencies and government bonds have seen an uncomfortable sell-off in recent weeks. Will it endure?

  • The unexpected rise in the US Dollar has prompted weakness in emerging market debt
  • Emerging markets had started to look like a crowded trade
  • The fundamentals and valuations still look reasonable for most emerging markets

It has been a tough few weeks for emerging market bonds and currencies. The unexpected rise in the US Dollar has prompted a sell-off, denting the ‘Goldilocks’ scenario that had run through most of 2017. For investors who had looked to emerging markets as a source of higher yields, this is a blow. Is it a long-term problem? 

Emerging markets had been resilient through the early part of 2018 as volatility spiked in developed market equities. However, the rise in the Dollar came as a shock – there had been widespread consensus that the Dollar was in a long-term bear trend. Emerging markets had started to look like a crowded trade and a strengthening of the US currency pricked the bubble.

The resulting slide in emerging market currencies and bonds has threatened the prevailing view that emerging markets are in a sweet spot, with improving fundamentals and attractive valuations. Emerging markets had been considered a key beneficiary of the synchronised growth in the global economy and fund flows had been robust.

To what extent does this recent wobble challenge that view? Sergio Trigo Paz, head of global emerging markets fixed income at BlackRock, believes that the fundamentals for emerging market debt remain strong: “Fundamentals have been improving over the past three years and many countries have shown stronger economic growth since the start of the year. Many have enjoyed a windfall from higher oil prices, which has helped them increase their fiscal surplus or reduce their current account deficits. This remains the key reason to allocate to emerging markets.” 

He also points out that valuations are cheaper at the same time as many of the uncertainties – the direction of the Dollar, US interest rates - have been resolved. If anything, he argues, this should make investors more enthusiastic about the asset class than at the start of the year. 

However, discernment is key. There are some countries with higher Dollar debt and economic difficulties that are particularly vulnerable to a strengthening in the currency. Turkey stands out, as do Argentina and Romania. All have short-term funding needs. Those with surpluses or no near-term funding needs are less vulnerable.

Nevertheless, there is a risk of contagion. It is difficult to sell down Turkey and retain India. Investors are more likely to pare back their exposure to the asset class as a whole. As such, while the problem may be isolated, its impact may not be. 


You need to log in to comment.