Is the emerging market risk cycle restarting?

Global liquidity has the force to shift markets, though emerging markets often get themselves wedged between the US and China, the two financial giants. In 2018 they experienced a serious liquidity crunch. Connected with last year’s steady rate hikes by the US Federal Reserve, a substantial part of the fall in EM liquidity conditions over the preceding 12 months was precipitated by widespread EM central bank tightening, enough of it a backlash to the EM currency sell-off brought about by the Fed.

Alongside this, there has been the worrying hint of restored (indeed if transitory) tightening by China’s huge People’s Bank (PBoC), now the world’s largest central bank. The argument for Chinese monetary easing this year seems compelling, but the evidence so far remains delicate, with the latest data from the PBoC’s daily open market operations revealing few manifestations of any significant liquidity upturn. Set against this grim picture, cross-border flows to EMs have remained to hold up well, faced by the marked contraction in Chinese capital flight and underpinned by increasing net inflows into several larger Asian EMs, including India, Korea and Taiwan, and even spilling over into cyclical commodity producers, like Australia.

History teaches that such cross-border movements are farsighted and show future increases in overall EM liquidity conditions. They comprise not merely the transfers of money made by the US and European-based fund managers but further the generally better-informed judgments of local firms and high net-worth investors, who move cash between offshore and onshore jurisdictions and who can react quickly to the constant fluctuations in the national political and economic trends.