Investors have withdrawn a record $70bn from emerging market bond funds this year, in a sign that soaring interest rates in advanced economies and the strong dollar are heaping pressure on developing countries.
Investors took $4.2bn out of EM bond funds in the past week alone, according to an analysis by JPMorgan of data from EPFR Global, a fund flow monitor — bringing the annual outflows to the highest level since the US bank began recording the data in 2005.
The investor flight underscores how emerging markets are facing mounting risks from surging interest rates in developed markets, which make the typically high yields on EM debt look less attractive. Powerful gains in the greenback also make it more expensive for EM countries to service dollar denominated debt and increase the cost of importing commodities, which are often priced in the US currency.
JPMorgan in September raised its forecast for EM bond outflows in 2022 to $80bn, having previously forecast $55bn.
Milo Gunasinghe, emerging market strategist at JPMorgan, described the outflows as relentless, with just seven weeks of net inflows in the year to date. They have also been broad, with investors pulling money from funds holding both local and foreign currency bonds.
Rather than weighing the relative risks of currency exposure, investors are simply getting out. It marks a sharp turnround: flows were positive into both types of bond funds for each of the previous six years, at a combined average of more than $50bn a year.
Gunasinghe said rate rises and bond sales by central banks, which have markedly reduced liquidity pulsing through global markets, “will keep a high bar for inflows for the foreseeable future”.
Shilan Shah, a 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 equity flows have gyrated, turning steeply negative for the past few weeks.
Many analysts saw an improvement in the outlook for EM assets earlier this year as economies began to emerge from the pandemic. Russia’s war in Ukraine derailed that, even though some commodity exporters were beneficiaries of sharply rising prices — until global inflation and the rising dollar turned against them. Some analysts, again, see an opportunity in today’s deeply discounted valuations.
But Shah, like Gunasinghe, expects outflows to persist for the rest of the year. Slowing global growth and global trade, with an associated decline in investors’ appetite for risk, will keep the headwinds coming, he said.
