Are the best days over for EM financial markets? – Capital Economics

Oliver Jones, Markets Economist at Capital Economics, points out that after a very strong run, EM bonds, equities and currencies have all faltered recently and although they have since bounced back a bit, they think that their best days are now over.

Key Quotes

“We forecast that EM dollar bond yields will rise in the next couple of years. In our view, tighter monetary policy in the US will cause “risk-free” rates climb a little further in the near term. And we think that credit spreads will widen as investors lose their appetite for risk.”

“We expect the spreads of local currency bond yields to pick up too. This would probably cause local currency bond yields increase in many EMs. But we forecast that yields will fall significantly in China and Russia, as monetary policy is eased by much more than most expect.”

“We doubt that a sustained recovery from the recent falls in EM equities is on the cards in the next two years either. Indeed, our end-2019 forecast for the MSCI EM Index is well below its current level. The prospects for EM economic growth mean that a repeat of last year’s surge in expectations for earnings is unlikely. Political developments are likely to prove less supportive too, and we think that the US stock market will come under more pressure next year as the US economy slows.”

“The Fed tightening that we are anticipating may not prove a big deal for most EM currencies between now and end-2019. Most have strengthened so far in its tightening cycle, and EM current account balances are generally much healthier than a few years ago. But we expect them to weaken regardless, as overseas investors’ appetite for EM assets wanes, commodity prices fall, and political developments take a toll.”

“Further ahead, we think that EM trend growth will be much slower than in the past. This suggests that the long-term prospects for real exchange rate appreciation are poor. But we doubt that slower trend growth will prove a disaster for EM bonds and equities.”