Emerging market (EM) debt had a strong start to Q1 2023 with traction building toward EM assets in January. This trend reversed in February due to stronger growth data in developed economies and a shift to higher terminal rate expectations. However, the quarter ended on a firmer note for EMD, with positive year-to-date returns in both local and hard currency markets. During the quarter, markets witnessed two 25 basis points (bps) hikes from the US Federal Reserve to take its federal funds rate range to 4.75–5.00%. The Fed decisions are expected to have a lesser impact on the policy stance of central banks in most EM economies, where domestic inflation dynamics dominate tightening cycles. EM inflation seems most likely to have peaked, with year-on-year EM Consumer Price Index (CPI) inflation standing at 8.8% at the end of February.
The effects of the recent events in banking sector, with collapse of Silicon Valley Bank and Credit Suisse, have not adversely impacted EMD assets significantly. In China, manufacturing activity data indicated strong demand, coupled with recoveries in the services sector and housing market. On geopolitical grounds, potential resolutions pertaining to Russia’s invasion of Ukraine are still ambiguous as the conflict reached its first anniversary in February. The quarter witnessed a decline in crude oil prices, which impacted the performance of Latin American countries with a higher beta toward commodity prices.
A global flight-to-quality and de-risking amid banking sector uncertainty dented market sentiment and impacted flows. Over the course of the quarter, the net flows were negative for both hard currency and local currency funds, amounting to –$4.7bn and –$1.8bn, respectively (source: J.P. Morgan).