Emerging markets are a disparate group based on their various economic narratives. But as investors seek to decrease their risk to the asset class, EM stress is growing with the risk that current selling pressure intensifies and sustains a bigger slide across the sector.
A good surrogate of contagion is the link between EM currencies. FX correlations for EMs have improved this year, but remain shy of the peak set in early 2016 as outlined by the Institute of International Finance. With the relative resilience of the Mexican peso - along with currencies like the Thai baht, the Korean won and the government-bolstered CNY [renminbi] - suggest hunt for safer havens in the EM space.
Whilst EM government and corporate bond yields have expanded in recent months, but they sit below the highs of early 2016 when China precipitated a global growth scare. With the ‘buy-on-the-dip’ approach in fixed income works over time and this dip is worth buying (notwithstanding the need to avoid certain countries that will struggle to return to any kind of macro stability).
The peril is of a further rise in correlations and higher EM bond yields as forced selling by investors overwhelms the case for careful buying of the asset class. Hefty selling of the South African rand on last week after the country entered its first recession since 2009 was followed by weakness in the Mexican peso and Polish zloty.
The currency market favours Mexico and Poland as proxies for EM risk At this juncture, the stakes are poised for EMs and much depends on fragile countries such as Turkey and Argentina remaining contained alongside a softening in trade tensions and US dollar strength.
Written by Scherzando Karasu, External Financial Journalist
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