EMs see capital flows reverse as proactive monetary policy largely succeeds

After a year of worsening economic and financial conditions, pressures facing emerging markets appear to be leveling off, leading to a rise in bullish investor sentiment according to FT and Reuters analyses. Proactive monetary policy tightening has staved off worst-case scenarios for outflows and depreciations without destabilizing economies with excessively high interest rates, which appear close to peak levels.

The dollar has also weakened in the past weeks, providing relief for emerging-market currencies. The combination of a falling dollar, slowing rate rises, and surprise resilience is leading to a risk-on streak and support for the EM recovery narrative after 15-25% recorded losses for the asset class.

This has lead investment bank forecasts for 2023 to turn bullish on EMs—based on assumptions that interest rates will stabilize, China will relax Covid restrictions and Russia won’t start a nuclear war. Bank of America’s latest global fund manager survey shows “long EM” is the top contrarian trade. UBS expects EM assets to earn between 8%-15%, while Morgan Stanley expects nearly 17% returns on local currency debt. Credit Suisse likes hard currency debt.

“It’s a kind of a wholesale de-grossing of risk,” said T. Rowe Price EM portfolio manager Samy Muaddi, who has started dipping his toe back into what he describes as “well-anchored” EMs such as the Dominican Republic, Côte d’Ivoire and Morocco.