“Usually you should expect a pause after having had the kind of inflows we’ve seen over the past year,” said Bareau. “But emerging markets are in better shape now in terms of GDP growth and earnings growth than a year ago.
Volatility risk
On the short term though, volatility is “a bit too low”, admits Bareau, and if it picks up investors will become nervous and take their profits.
But on the other hand, it’s difficult to see an immediate catalyst of volatility. Bareau: “We know volatility will pick up at some point, but so far volatility has only picked up at a country level. Last month it happened in Brazil [when president Temer was accused of bribing another politician], before that in South Africa but volatility remained constrained at the country level. A systemic threat to the asset class can only come from China really.
Dehn notes that, traditionally, a strong dollar, a hawkish Fed and plummeting commodity prices have been catalysts for turmoil in the asset class. “But all of these risks are behind us now.”
Oil is trading below $45, the Fed has already hiked rates three times and is likely to reduce the pace of its hiking amid lower than expected inflation data.
“And the dollar has probably peaked. EM currencies have room to catch up some of the ground they lost over the past few years,” says Bareau.
That would obviously benefit local currency bonds most. “I’m not particularly bullish on EM currencies, but even if they recover only half of the losses they sustained against the dollar since 2014, investors will make a great return, as year-to-date they have only outperformed the dollar by 5% on average,” says Dehn.
Richard Turnill, global chief investment strategist at Blackrock, also perceives few immediate risks for emerging market debt.
