A movement towards growth would be beneficial to emerging markets, as they take advantage of the growth of more advanced economies. With regard to inflation, he says emerging market central banks were already raising their base rates last year because they don’t have the credibility of the likes of the Fed or the Bank of Canada. This means that the base effect will probably start in emerging economies and inflation rates will start falling soon.
Also notable, says Liu-Fong, is the surprising strength of the US dollar over the past year. As EM central banks raised their base rates to counter strong inflation in their respective economies, EM local rate loans sold out. Because a strong greenback becomes a headwind against EM currencies, creating an additional layer of weakness.
“You basically had two engines sort of taking you down,” he says. “You had weak FX returns, and you had weak returns on local-rate bonds.”
It is only the early weeks of 2022, but Lu-Fong says that so far EM local-rate lending and FX have done remarkably little loss; At the time of the interview with WP, local-rate debt from EM countries was outperforming both EM sovereign debt and EM corporate debt in dollars. The message they are getting is that EM local debt has generally already reevaluated already in 2021, when it fell to a painful 8.75% low.
He says EM dollar debt on both the corporate and sovereign sides has been hurt by their relatively high sensitivity to the Treasury. As the Treasury yield rose higher, it took away some of the shine from the spread offered by the EM dollar-loan. But since too much downside has been priced in, Lu-Fong believes that the downside will start to decline.