Emerging market dedicated bond fund inflows are expected to fall by over half in 2020 on account of less accommodative monetary easing and rising EM country risks, according to JPMorgan. Inflows are predicted to slow to around $30 billion, down from around $65 billion in 2019, according to analysts at the bank.
With a peak of $17 trillion of global bonds offering negative returns in 2019, investors turned to EM bonds to pick up yield, prompting above-trend demand for the asset class last year. Now bankers expect a rebalancing.
“Developed market and emerging market monetary easing is likely to be less supportive… and our modest return forecasts for 2020 point to lower return-following EM bond flows,” say the JPMorgan analysts. “For institutional investors, we expect below-average strategic flows despite the global search for yield, given EM country risks and late-cycle concerns.”
The challenge for EM returns comes from the starting point of a strong 2019 performance driven by the substantial fall in global yields, which is unlikely to be repeated.
EM sovereigns returned 12.4%, corporates 12.1% and EM local bonds 9.7% as of November 2019. By contrast, JPMorgan expects EM sovereigns to return 2.6% in 2020, and corporates 4.8%.
Koon Chow, UBP
Fund flows to EM will largely depend on the state of the US economy, with a recovery and higher rates in the US resulting in a rotation out of emerging market debt, say bankers.
“If you buy into US recovery story and rates going up, it would be logical to expect a rotation away from EM,” says a Dubai-based debt capital markets banker.
But not all are convinced that a sustained US recovery is likely and that EM debt will lose the appeal that drove vast inflows in 2019, at least in the near-term.
“Fundamentals haven’t changed very much and the global yield environment is generally more depressed – our yield relative to developed markets hasn’t changed so why should flows be different,” says Koon Chow, a macro strategist in EM fixed income at UBP Asset Management.
“It makes no sense at all. Who would hike when geopolitical risks are rising and inflation is depressed? You have to be pretty unconventional as a policy maker.”
Fundamentals haven’t changed very much and the global yield environment is generally more depressed – our yield relative to developed markets hasn’t changed so why should flows be different- Koon Chow, UBP Asset Management
Analysts at Standard Chartered recently said it remained bullish on near-term flows into EM assets, and the search for carry in EM fixed income is likely to remain constructive in 2020. However, they note that a series of elections in the second half of 2020 could result in more volatile flows.
Recent data from the US gives little hope for an imminent recovery and inflation remains below the Federal Reserve’s 2% target. JPMorgan expects first quarter US growth to slow to around 1.25%.
ING analysts see risks skewed towards weaker growth and the opportunity for a couple more US rate cuts in early 2020.
Focus now turns to the second phase of the US and China’s trade negotiations. Protracted negotiations over phase one proved a laggard on global growth in 2020. Analysts at ING say their base case is a tariff stalemate in 2020 with the US assuming a tough stance and stepping up its trade war rhetoric.
“A comprehensive deal with China before the election seems unlikely, though another limited ‘deal’ might emerge if weakening US economic conditions or the election calculus demand it,” says the Dutch bank in a report published on January 8.
EM hard currency sovereign and corporate issuance will also decline against 2019 but will remain elevated due to the rise in bond maturities.
The bank expects $142 billion of gross issuance and $121 billion mean, so net financing will be just $21 billion. For corporates, the bank sees $432 billion of gross supply and $356 billion of cash flows.