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Will EM fund outflows reverse in 2024?

EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp

RAMYA RS
Analyst
DIFC Branch – Dubai
T:+971 (4)387 5031
E: ramya.rs@ae.mufg.jp

LEE HARDMAN
Senior Currency Analyst
Global Markets Research
Global Markets Division for EMEA
T: +44(0)20 577 1968
E: lee.hardman@uk.mufg.jp

PAUL FAWDRY
Head of Emerging Markets FX Desk
Emerging Markets Trading Desk
T: +44(0)20 577 1804
E: paul.fawdry@uk.mufg.jp 

MUFG Bank, Ltd.
A member of MUFG, a global financial group

Macro focus

A central EM question for investors in 2024 is whether the persistent fund outflows in EM credit that began in earnest in 2022 will continue – irrespective of a relatively benign performance of the EMBI Global Diversified benchmark this year, with tighter spreads and positive total returns. We examine the divergence between the recent EM spread performance and IIF fund flows data, as well as what could propel inflows going forward. Part of this may be explained by the design of the IIF flows data – reflecting only a snapshot of overall flows. Balance of payments data are also consistent with spread performance, where a multitude of EMs that have witnessed the largest outflows since 2022 are either in default or debt distress (see here). Looking ahead, our examination points to IIF flow data being strongly correlated with total returns, as opposed to spread performance, signalling better total returns will be pivotal for inflows next year. Also, inflows into EM tend to be remarkably high in episodes of high EM versus US growth, and low rate volatility. We anticipate many of these factors to begin to transpire in 2024.

FX views

Emerging market currencies have corrected lower over the past week giving back some of their gains from last month. ZAR has underperformed other EM FX during recent USD sell-off. Falling commodity prices remain a weight on ZAR. With a relatively high hurdle for a dovish surprise, the USD should continue to trade on a firmer footing in the week ahead. 

Trading views

Words like “on the one hand” are ones traders should avoid. Going into this week’s US CPI report we are almost at the same level for EMFX even if yields are 25bps lower. Most risk indicators are screaming buys for EMFX with the soft landing scenario playing out in the US. 

Week in review

In Poland, the NBP remained on hold. November CPI in Egypt and Hungary slowed, while Russia’s November headline inflation rose at a faster pace. Meanwhile, South Africa’s Q3 GDP contracted more than expectations. Moody’s Ratings upgraded Oman’s rating to Ba1, with a stable outlook.

Week ahead

In Russia, we expect the CBR to remain on hold. November CPI data in Israel and South Africa will be in focus.

Forecasts at a glance

In a world of tightening global financial conditions and questions about the liquidity implications of the now-finalised US debt ceiling, we see a degree of macro risks for EM economies in H2 2023, with external funding requirements the central concern. We expect EM growth to trough this year but remain below potential in the 2024 recovery. The silver lining is that subdued growth should cap inflation, facilitating monetary policy easing where external balances allow.

Core indicators

EM inflows totalled USD1.1bn in the week ended 08 December, with inflows into equities and bonds at US0.8bn and USD0.3bn, respectively.