Emerging markets brace for US policy shift

Foreign investment in emerging markets has dropped to the lowest level since the financial crisis as investors brace for the fallout of the first US interest rate rise in nearly a decade.

Years of growth fuelled by access to cheap funding by virtue of low interest rates in the developed world and China’s robust appetite for commodities are seen ending, leading economists at the Bank of International Settlements to warn of negative spillovers as borrowing costs rise.

Prices in popular emerging market debt and equity benchmarks have already fallen, while net inflows from overseas investors have dropped from $285bn in 2014 to $66bn this year, according to the Institute for International Finance, a group representing the world’s largest financial firms.

Investors are divided as to whether the anticipated rate increase by the US Federal Reserve in December has already played out, or will intensify stress for indebted companies and economies.

“This has been a miserable year for EM,” said Paul McNamara, investment director of emerging markets at GAM, the Swiss fund house. “There has been a steady bleed out of assets and no one is certain what shape the market might be in this time next week.”

Anxiety has been fanned by the build-up of corporate debt in emerging markets, which doubled between 2008 and 2014 and has been one of the fastest growing areas of the global bond market.

“Policymakers around the world are cognisant of the impact the Fed decision will have and are worried, which makes us worried,” said Simon Lue-Fong, head of global emerging debt at Pictet Asset Management. “People are saying the decision is priced in but seeing as no one knows exactly what will happen.”

Emerging market focused fund groups have endured a torrid year with sharply lower assets under management at Aberdeen and Ashmore. EM exchange traded funds have also suffered heavy redemptions, with investors pulling $9.5bn from BlackRock’s iShares MSCI Emerging Markets and Vanguard’s FTSE Emerging Markets, according to ETF.com.

“Even if you have made your peace with a Fed rate rise there are other reasons to be nervous,” said David Hauner, head of emerging markets at Bank of America Merrill Lynch, who points to falling oil prices and the slowdown in China to illustrate why market volatility measured by the CBOE’s Vix index, a barometer of investor sentiment, has been elevated since August.

Benchmark oil prices dropped below $40 a barrel last week, the lowest level in six years, darkening investor sentiment towards commodity-linked companies and exporting countries including Brazil, Russia and South Africa.

Brazil’s real has lost close to half its value against the US dollar this year and the Russian rouble is at its weakest level against the dollar since the summer. The importance of oil to emerging markets means low prices will continue to weigh on sovereign credit profiles of big exporters next year, according to Fitch, one of the worlds’ leading credit-rating agencies.