Policy Normalisation and Potential Impacts on Emerging Markets

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Tuesday, September 21, 2021 / 03:47 PM / by United Capital Research / Header Image Credit: iStock


Since the initial foreign capital flight triggered by the pandemic in early 2020, Emerging Markets (EMs) have benefitted from the knock-on effects of accommodative monetary policy, which prompted investors to seek higher yields. However, with inflation rising across developed economies and decent economic rebound from last year's covid-induced slump, higher interest rates are on the horizon. In EMs, monetary tightening is afoot, as the most-recent policy decisions made by key EM central banks (Russia, Turkey, and Brazil) were rate hikes. In developed markets, policymakers have recently indicated a shift to tightening, albeit softer, with the US Federal Reserve (US Fed) and the European Central Bank signaling imminent tapering of asset purchases as early as Dec-2021.

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Still, the prevailing sentiment is that pressures on inflation will be short-lived, allowing the US Fed to conduct a smooth and contained normalisation of its balance sheet, and pushing any interest rate hikes further into the future. Recent inflation prints from the US bolster this position and indicate that rates will remain low for the foreseeable future. Until then, global liquidity and financing conditions will remain supportive of fund flows to EMs.

Regardless, fund flows to EMs will be idiosyncratic. On the one hand, we expect to see more EM debt issuances as governments and corporations look to take advantage of low rates while they still can. In that vein, the upcoming issuance of Eurobonds by Nigeria in Oct-2021 is well-timed and should be priced favourably. On the other hand, EM equities will likely continue to struggle as slow vaccination progress, as well as increased regulatory crackdowns by Chinese regulators weaken sentiments. Notably, The MSCI EM Index is down 0.9% YTD, compared with the MSCI World Index (+15.1% YTD) and the MSCI EAFE (+9.4% YTD). For Nigeria, we expect FX illiquidity to remain the elephant in the room until Foreign Portfolio Investors see a marked increase in oil production or another Naira devaluation.

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