Investment Institute
Macroeconomics

Tough love for emerging markets has improved their resilience

KEY POINTS
Emerging markets (EM) have evolved significantly over recent decades supported by financial markets liberalisation and improved macroeconomic institutions.
Overall EM bond markets account for only slightly more than a quarter of global debt while equities are just shy of 10% of world market capitalisation.
Higher US yields and a stronger US dollar have drained portfolio flows from EM over the past three years, despite decreased sensitivity of EM local currency bond yields to the US during the recent Federal Reserve rate hike episodes.
Slowing US GDP and Fed easing should reverse these portfolio outflows. Continued growth resilience should trigger investors’ interest in EM assets. However, this outlook would look stronger if there wasn’t the possibility of the US electing a protectionist president in Donald Trump.

In this note we consider how the structural improvements in EM over recent decades should coincide with an improving short-term growth environment, with global financial conditions looking set to ease over the coming years as the world – and specifically the US economy – passes beyond the inflation shock and central banks begin to ease monetary policy. This, combined with longer-term structural drivers, could see several EM economies supply the raw materials required for climate transition technology. Meanwhile the prospect of artificial intelligence (AI) offers unique opportunities for EM economies to accelerate institutional reforms by leapfrogging the resource-intensive methods of pre-AI developed economies.

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