Emerging markets had a very poor first half to the year, with equities entering into a bear market and bonds suffering losses too. However, in recent weeks, bonds have started to rally, which has made some hopeful a big rebound is on the way. That said, American fund managers are not rushing back in, saying that the bonds are very risky. In fact, a survey by Citi found that even though prices are rising, top EM bond fund managers are getting bearish and are setting aside more cash in anticipation of losses.
FINSUM: Dollar-denominated bonds from the likes of Argentina, Egypt, and Brazil have their appeal—high yields, but they do hold a lot of risk, especially in a period of rising rates and a rising Dollar.
(Rio de Janeiro)
Emerging markets have been in a really tough patch lately and generally entered a bear market recently. Their losses have been urged on by higher rates and a stronger Dollar. However, the situation may be about to turn around. The argument is from UBS Asset Management, who says that EMs have de-risked from five years ago during the Taper Tantrum, and that they are in a much stronger financial position now. In particular, whereas investors were worried about EM risk during the Taper Tantrum, now the losses have just been down to a rising Dollar, which does not signal any fundamental weakness.
FINSUM: Our worry with this argument is the lack of a catalyst. While all of what UBS argues may be true, what will cause the market to comprehensively reverse?
Investors who had been betting on emerging markets stocks might want to take notice of what is happening in the Treasuries market. While the explanation is a little technical, hear this: since the US deficit is set to rise rapidly, the US will see a surge in Treasury issuance. That big jump is issuance will suck up investor Dollars, and is likely to greatly wound Dollar-based EM funding. The Fed will also be forced to stop shrinking its balance sheet, which will also exacerbate the situation for EMs.
FINSUM: It sounds like the EM funding market is going to take a hit, which could have major ripple effects throughout the whole asset class.
Something monumental, and very troubling, happened in China his week. The central committee there recommended scrapping the two-term limit for leaders, meaning Xi Jinping will stay in power indefinitely. This has “has put us back 30 years”, said one Chinese commentator close to the situation. One Australian academic comments that “We’ve had so many steps backwards [under Xi] … Media controls have become stricter, internet controls have become stricter. And now one of the few seemingly effective checks on a senior leader’s power — that he can only be in power for two terms — is now just being completely cast aside”.
FINSUM: Even for a country with no elections this seems quite authoritarian. We don’t suspect any immediate fallout, but this could be a slow-building drama.