March 23, 2023

Investors withdrew a record $70 billion from emerging market bond funds this year, a sign that rising interest rates in advanced economies and the strong dollar are putting pressure on developing countries.

According to an analysis by JPMorgan of data from EPFR Global, a fund flow monitor, investors took $4.2 billion from emerging market bond funds in the past week alone. .

Investors’ flight underscores how emerging markets face increasing risks from rising interest rates in developed markets, making the typically high returns in emerging markets seem less attractive. Strong dollar gains also make it more expensive for emerging countries to pay off dollar-denominated debt and increase the cost of importing commodities, which are often priced in US currencies.

In September, JPMorgan raised its forecast for emerging market bond outflows in 2022 to $80 billion, where it had previously forecast $55 billion.

Milo Gunasinghe, emerging markets strategist at JPMorgan, described the outflows as relentless, with just seven weeks of net inflows in the year so far. They were also broad, with investors drawing money from funds holding both local and foreign currency bonds.

Column chart of flows in and out of EM bond funds, $billion showing EM bond funds have experienced the largest outflow ever

Instead of weighing the relative risks of currency exposure, investors simply step out. It marks a sharp turnaround: For the past six years, flows to both types of bond funds have been positive, with a combined average of more than $50 billion a year.

Gunasinghe said rate hikes and bond sales by central banks, which have significantly reduced the liquidity flowing through global markets, “will keep the bar for inflows high for the foreseeable future.”

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Shilan Shah, senior economist at Capital Economics, said cross-border flows by non-resident investors to the limited group of emerging markets that provide timely data tell a similar story: bond flows have been consistently negative this year, while stock flows have spun around in recent weeks. became strongly negative.

Many analysts saw an improvement in the outlook for emerging assets earlier this year as economies emerged from the pandemic. Russia’s war in Ukraine derailed that, although some commodity exporters benefited from soaring prices – until global inflation and the soaring dollar turned against them. Some analysts see another opportunity in today’s heavily discounted valuations.

But Shah, like Gunasinghe, expects the outflow to continue for the rest of the year. Slowing global growth and trade, with a corresponding decline in investor risk appetite, will continue the headwinds, he said.