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Emerging Market Debt Market Commentary: Q4 2023

Emerging market (EM) debt was hit by reduced investor risk appetite in the early part of the quarter amid continued volatility in US Treasury yields and geopolitical tensions related to the Israel-Hamas conflict. Uncertainty eased later in October on hopes that the hostilities would not escalate into a wider conflict that draws in other parties. Investor optimism towards EM debt recovered as the quarter progressed, aided by a continued deceleration in inflation. Retracing US Treasury yields and a reversal of US dollar strength in November brought about a more constructive macro backdrop for EM assets. Worries that EM inflation could rebound moderated, supported by a drop in commodity prices; this was particularly the case for oil, which slumped by about 21% in Q4. Despite the slow growth narrative on China, the country’s economic data (including Q3 GDP, retail sales, and industrial production) surprised to the upside.

The risk backdrop for emerging markets improved further in December following a dovish pivot by the US Federal Reserve (Fed) in its December meeting. With the ongoing resilience of the US economy, markets continued to factor in the possibility of the Fed retaining a data-driven approach to determine when to ease monetary policy, with a likely focus on economic growth and labour market data. Investor sentiment towards the end of the year lifted by increasing market expectations of monetary policy convergence between EM and DM central banks in 2024. With real yields staying high against a backdrop of declining inflation, investor focus remained on the potential for EM rate cuts in 2024. Election campaigns and outcomes in some EM countries contributed to rising hopes of economic reforms through political change, especially in Egypt and Argentina.

Broad interest towards EM debt improved as the quarter-end drew closer. but net flows into hard currency and local currency funds were negative for full three-month period, amounting to -$9.3bn and -$5.1bn, respectively (Source: JP Morgan).

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