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Categorized | Currencies

Investors re-engage with emerging markets

Posted on March 31, 2014

Global investors are more willing to engage in emerging markets than at any time since the sell-off of last summer, according to research by Morgan Stanley – whose analysts coined the term “fragile five” to describe the most vulnerable countries.

Despite mounting evidence of a slowdown in China, tensions over Ukraine and tense election campaigns in several countries, the currencies previously seen as most exposed to the US Federal Reserve’s tapering have rallied in recent weeks.

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    Evidence of economic rebalancing and hopes that elections will usher in reform-minded governments have sent Indonesia’s rupiah up more than 7 per cent against the dollar since the start of the year. India’s rupee is up 3.2 per cent and Brazil’s real has gained 3.9 per cent. The Turkish lira and South African rand – grouped with them in the “fragile five” – have also rallied since interest rate hikes in both countries, and low volatility across currency markets, tempted investors back into carry trades.

    The Institute of International Finance, which has just begun publishing estimates of portfolio flows to emerging markets, said last week that the 30 countries it tracks had received inflows of $39bn in March, up from $25bn in February and $5bn in January.

    The shift in sentiment “has some fundamental support in the near term”, according to Manoj Pradhan, a senior economist at Morgan Stanley, given hopes of stimulus from Chinese policy makers, the receding threat of sanctions against Russia and signs that investors are taking tapering in their stride for now.

    The bank’s assessment is striking, because Morgan Stanley has been consistently bearish on emerging markets for much of the last year – and still warns investors against mistaking this near-term stabilisation for a longer-term turnround.

    Some are more bullish. Analysts at Commerzbank last week gave an upbeat outlook for emerging market local currency bonds, arguing that investors had had time both to digest the Fed’s plans and to price in the political risks in many emerging markets.

    Other analysts urge greater caution. “External vulnerabilities are still out there,” warned strategists at Citigroup. “The recovery in capital flows could be a temporary phenomenon, ahead of a more dramatic move in US rates over the next quarters.”

    “Emerging markets are experiencing what can be termed a ‘capitulation of bears’,” wrote strategists at BNP Paribas, who advised betting against further price rises.

    Matthew Cobon, head of currency at Threadneedle Investment, voiced a similar view, saying the recent rallies chiefly reflected an unwinding of short positions.

    Mr Pradhan said that mainstream investors who had previously withdrawn from emerging markets had now become the most enthusiastic about their prospects, while EM-dedicated funds were more tentative. “It seems likely to us that many investors feel they cannot remain on the sidelines,” he said.