Emerging-market bonds are suffering their worst losses in nearly three decades, hit by rising global interest rates, slowing growth and the war in Ukraine.
The benchmark index of dollar-denominated emerging market sovereign bonds, JPMorgan EMBI Global Diversified, has delivered total returns of around minus 15% so far in 2022, its worst start to a year since 1994. Broad market rally in recent days, ending a seven-week losing streak for Wall Street stocks.
Nearly $36 billion has flown out of emerging-market mutual and exchange-traded bond funds since the start of the year, according to EPFR data; Stock market flows have also reversed since the beginning of this month.
“It’s certainly the worst start I can remember across the entire asset class and I’ve been doing emerging markets for over 25 years,” said Brett Diment, head of global emerging markets debt at Abrdn.
Developing economies have been hit hard by the coronavirus pandemic, straining their public finances. Rising inflation, slowing global growth, and the geopolitical and financial disruption caused by Russia’s war in Ukraine have added to the economic pressures they face. Investment outflows threaten to worsen their problems by tightening liquidity.
David Hauner, head of emerging markets economics and strategy at Bank of America Global Research, said he expected the situation to get worse.
“The big story is that we have so much inflation in the world and policymakers continue to be surprised at how high it is,” he said. “That means more monetary tightening and central banks will continue until something breaks, the economy or the market.”
Yerlan Syzdykov, global head of emerging markets at Amundi, said higher yields in developed markets like the US, driven by central bank rate hikes, make emerging market bonds less attractive. . “At best you will earn zero, at worst you will lose money [this year],” he said.
Hauner said rate hikes in major developed market economies were not necessarily bad for emerging market assets if they were accompanied by economic growth. “But that’s not the case now: we have a big stagflation problem and central banks are raising rates to crack down on runaway inflation in some places, like the US. This is a very unhealthy backdrop for emerging markets.”
China, the world’s largest emerging market, has faced some of the strongest selling.
Concerns about geopolitical risk, including the possibility of China invading Taiwan in the wake of Russia’s invasion of Ukraine, have been exacerbated by the economic slowdown as the government imposed draconian lockdowns in pursuit of its zero-Covid policy, Jonathan said. Fortun, an economist at the Institute of International Finance, which monitors cross-border portfolio flows to emerging markets.
Chinese assets have received large passive inflows in the past two years, he noted, following the country’s inclusion in global indices, which meant fund managers trying to mirror its benchmarks automatically bought Chinese stocks and bonds.
This year, however, such flows reversed, with more than $13bn flowing out of Chinese bonds in March and April and more than $5bn leaving Chinese stocks, according to IIF data.
“We are targeting negative outflows from China for the rest of this year,” Fortun said. “This is a very big business.”
Fund managers have not allocated some of the money withdrawn from China to other emerging market assets, he said, leading to widespread withdrawal: “Everyone is leaving the entire emerging market complex as an asset class and heading to safer assets.
The shock to commodity prices caused by the war in Ukraine has increased pressure on many developing countries that rely on imports to meet their food and energy needs.
But this has also produced some winners among commodity exporters. Diment en Abrdn noted that while local-currency bonds in the JPMorgan GBI-EM Index have delivered total returns of minus 10 percent year-to-date in dollar terms, there is wide divergence across countries.
Bonds issued by Hungary, which is close to war and reliant on Russian energy imports, have lost 18 percent so far this year. Those of Brazil, a big exporter of industrial and food staples, rose 16 percent in dollar terms.
Diment said emerging market debt valuations “arguably look quite attractive right now” and that Abrdán has seen net inflows so far this year into his emerging market debt funds.
However, Bank of America’s Hauner argued that the bottom will only be reached when central banks shift their attention from fighting inflation to promoting growth. “That may happen sometime in the fall, but it doesn’t look like we’re there yet,” he said.
Syzdykov said it depended on whether rising inflation recedes, returning the global economy to a balance between low inflation and low interest rates. The alternative is for the US to slip into recession next year, adding to the drag on global growth and pushing emerging market yields further, he warned.