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Emerging Market Debt Market Commentary: Q2 2023

At the start of the second quarter, emerging market (EM) debt struggled for direction in the aftermath of the market turbulence that stemmed from banking sector concerns in the US and Europe. Investor risk appetite was initially low as markets sought greater clarity on how the latest events might impact the Federal Reserve’s policy path. Such concerns eased later in April as strong US bank earnings reports provided greater comfort around balance sheets. Despite easing inflation pressures and the high carry on offer with EM debt, performance in May was hit by concerns surrounding a possible US debt default as debt ceiling talks dragged on. However, the end of May brought relief in the form of a tentative agreement between US President Joe Biden and Speaker of the House Kevin McCarthy to raise the US debt ceiling. Despite underwhelming growth data from China, the quarter ended on a relatively stronger footing for emerging markets with lower volatility and narrowing spreads.

The market-implied probability of additional policy rate hikes by the Fed increased, notwithstanding a pause in the rate hike cycle in June. However, the Fed’s decision to pause did not have a material impact on the policy stances of most EM central banks, whose tightening cycles are more skewed towards domestic inflation dynamics. Headline inflation peaked across the EM universe, with downside inflation surprises being observed. In a major shift from President Recep Tayyip Erdogan’s unorthodox policies to tame inflation (which included rate cuts), Turkey’s central bank raised its main interest rate from 8.5% to 15% in an effort to shore up depleting reserves. Meanwhile, softening growth data from China impacted commodity demand, especially for industrial metals. After trending lower through most of the quarter, crude oil prices rebounded in June, aided by a drop in inventory levels and plans by some producers to reduce supply. Performance of some Latin American EM economies with a higher beta towards commodity prices were impacted as a result.

Net flows during the quarter for hard currency and local currency funds were -$6.9bn and +$1.4bn, respectively. (Source: JP Morgan).

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