Emerging Market Debt: Market Commentary Q2 2022

Emerging markets (EM) debt experienced another sharp correction in Q2 2022 amid challenging macro conditions for EM assets, with investors’ concerns widening from the war in Ukraine to the stagflation threat. West Texas Intermediate (WTI) crude oil stayed below $125 per barrel through Q2, with prices moderating from the March peak. The threat of a Russian gas embargo looms after the European Union (EU) partially banned Russian oil imports, an action that could strike a material blow to Europe’s economy — Russian gas accounted for 45% of the EU’s gas imports in 2021. Recession concerns emanating mostly from weakening G7 growth weighed on the commodity FX, particularly in Latin America (LatAM). More positively, the COVID situation in China improved with lockdown restrictions relaxed in Shanghai as the national daily cases count fell below 200, underpinning a rebound in the manufacturing purchasing managers’ index (PMI) to 50.2 in June. This followed three consecutive months of contraction — readings above 50 are indicative of growth.

US CPI inflation remained elevated in Q2 with the headline annual rate of 8.5% in May ticking up from 8.2% in April. To control the surge in inflation, the US Federal Reserve raised the federal funds rate by 75 bps (its biggest hike in 28 years) at its June meeting, catching many market participants off guard. The Fed also acknowledged the slowdown in the economy by revising its growth forecast for 2022 down to 1.7% from the 2.8% level it projected in March. The US Conference Board’s consumer confidence index dropped to 98.7 in June, its lowest level since March 2021. The US dollar appreciated against most EM currencies in the quarter as it was supported by rising Treasury yields and demand for ‘safe haven’ assets. Over the course of Q2, hard currency outflows were -$14.4bn, while local currency outflows amounted to -$18.9bn (source: JP Morgan).