Emerging Markets: Risk of fund outflows posed by higher US interest rates - Nomura

The yield on the benchmark US Treasury 10yr note is above 3% for the first time since 2014 and with the US expected to continue monetary tightening and other major countries moving toward normalization of their monetary policies, long-term interest rates on the whole are on the rise, explains Takahide Kiuchi, Executive Economist at Nomura.

Key Quotes

“This trend raises concerns that an outflow of funds from emerging markets could disrupt those countries' financial markets, which could trigger a global economic downturn. We are already seeing currency depreciation and higher interest rates in some emerging countries. Improving economic fundamentals in emerging countries, including better external balances and increased foreign exchange reserves, have strengthened their financial markets and made them more resistant to external shocks, such as rising US interest rates. However, investors investing in securities in emerging countries include a growing percentage of relatively new entrants, such as overseas investment funds and exchange traded funds (ETFs) that have a strong tendency to unwind funds quickly in the face of changes in the investment environment, including rising interest rates.”

“How these relatively new players in the emerging markets will act in the face of rising interest rates is hard to forecast because of the small sample and short history of their involvement in emerging financial markets. Moreover, the normalization of monetary policy in the more economically advanced countries will include a factor we have not seen before, namely the reduction of assets purchased as part of their accommodative monetary policies.”

“Given this lack of past precedent, we cannot not rule out the possibility that the financial markets in emerging countries could be greatly disrupted by the emergence of unforeseen circumstances. While financial market and economic conditions in emerging countries are in good shape and interest rates remain low, countries facing challenges must increase the robustness of their fund procurement and enhance their resistance to external shocks.”