Citibank analysts remain bullish on emerging markets despite tightening monetary conditions in developed markets: In an August 1 report they wrote:
The monetary policy environment in DM has recently turned more hawkish and yet capital flows to EM are holding up, having attracted some $160 billion in portfolio flows in the first half of the year. But the divergence between EM spreads and US real 10-year yield makes it worthwhile revisiting whether this is sustainable.
We previously identified four reasons why EM is more resilient this time around: DM monetary policy adjustments are gradual and priced in, current accounts are bolstered by strong Chinese growth, capital outflows from China are under control and EM is generally less vulnerable as financing gaps have fallen, external balance sheets have improved, real interest rates are high and currencies sufficiently cheap.
Analysts add that oil in a “sweet spot” for emerging markets:
Oil prices are currently in a ‘sweet spot’, albeit a fragile one. The disinflationary consequence of low oil prices are helping to pull capital towards EM, while the increase in oil prices compared to 2015/16 has helped to reduce investors’ concerns about EM oil exporters. The current price level might though not remain a ‘sweet spot’ as oil exporters have started to lag other EM in reserve accumulation.
However, we are not too worried about the outlook for oil prices. In fact, the path of oil prices could turn out to be ‘ideal’ in the sense that it is sufficient not to raise questions about the prospects of commodity exporters while not accelerating inflation in commodity-importing countries.
We think it’s worth being braced for a shock, but not a devastating one. DM monetary conditions are bound to tighten, especially when the Fed starts unwinding its balance sheet, but we think the impact of this on US 10Y yields will be modest. And with high real interest rates, favourable commodity price dynamics, global risk aversion at record lows and a successful ‘de-risking’ process working in its favour, EM in 2017 should be able to handle a controlled reduction in capital flows.”