US economic recovery expected to boost emerging markets assets

Emerging markets

Economic restart and greater stability in US bond markets is likely to support investment in emerging market debt, according to BlackRock Investment Institute. 

The research arm of the world’s largest asset manager says valuations in emerging markets “appear relatively attractive in a world of low yields after a choppy start to the year”. 

Yields in emerging market debt spiked after a bond market sell-off pushed US 10-year Treasury yields above 1.7 per cent in March, which BlackRock says reflected a “faster-than-expected activity restart combined with large US fiscal stimulus”.

“We see greater stability in yields and in the US dollar over coming months,” writes BlackRock Investment Institute.  

“This should support EM local-currency debt, in our view. Its valuation appears attractive relative to other income sources such as high yield debt.”

Emerging markets have been supported by loose financial conditions and low interest rates, which make it easier for investors to borrow money, and encourage investment into riskier assets.

Emerging markets equities remain fund managers’ most preferred region, according to a Bank of America’s monthly survey in April, with investors also found to have an overwhelmingly positive outlook for the global economy.  

BlackRock has taken an ‘overweight’ position in emerging markets equities. “We see them as principal beneficiaries of a vaccine-led global economic upswing in 2021,” writes the asset manager.

A record high 57 per cent of investors now expect above-trend growth and above-trend inflation in the next 12 months, according to Bank of America.

Confidence in the global economic recovery has been rising on the back of the speed and success of vaccination roll-outs in developed countries and some emerging economies, including Chile and Central Eastern European countries.

This is helping to boost growth forecasts in emerging market economies, with ratings agency S&P expecting real GDP growth in the region to hit 6.4 per cent in 2021, more than making up for a 5.4 per cent contraction in 2020.

S&P upgraded its expectations on the back of higher global growth and foreign demand. Strong growth in US and China is expected to set the stage for higher demand in manufacturing and commodities, which are central sectors in many emerging market economies. 

BlackRock writes: “The powerful economic restart is likely to support many commodities in the near term, including oil. This should benefit the assets of commodity exporters, including some EMs.” 

The asset manager notes that copper, an export of some emerging economies, has rallied in the past year and is expected be supported by “structural demand for copper and certain industrial metals associated with a transition toward a low-carbon economy for years to come”. 

Nevertheless, cases of coronavirus have been rising sharply across some emerging economies including India, Thailand, and Chile in recent weeks.

“Some EMs face near-term challenges including a virus resurgence, slow vaccine rollouts and rising inflation that may force the hand of their central banks. Yet we expect their economic restart to likely be delayed – but not derailed,” writes BlackRock Investment Institute. 

There are also fears that rising bond yields may push up financing costs for emerging market governments and slow down the recovery.

Ratings agency S&P writes: “So far, the adjustments to the recent increase in long-term US Treasury yields have been generally orderly for most EMs, and our baseline is that this will remain the case.”

“In other words, we don't expect an EM-wide "tantrum", and at this point see a significant tightening in financing conditions across EMs as a downside risk to our baseline.”