With the market increasingly looking at the potential of emerging markets, what’s front of mind from your side?
One of our key expectations for 2024 was a turnaround in asset allocation in favour of emerging markets (EM), especially for diversification purposes as US positions became more concentrated. After record levels of outflows since the Fed shifted towards a tightening cycle, the stage appeared set for recovery flow as G10 central banks embarked on easing. Extremely attractive valuation differentials should also have played a role.
However, as Fed easing expectations are now being pushed back and growth continues to struggle in key emerging economies, we acknowledge that the outlook for rotation away from the US and into emerging markets has become challenging.
Read more: Buy-side trading head recommends cautious approach to emerging markets despite strong investor interest
On a 12-month rolling basis, flows into EM fixed income are back to the lowest levels since March 2023, which is understandable considering the Fed was still in a tightening cycle then. Within emerging market flows, China – and APAC – remains the region where we see the most potential for asset rotation flows.
What’s the current state of play when it comes to currencies in those regions?
In currencies, the JPY’s sustained weakness has largely held the region back but given the Japanese authorities now appear to have reached their limits in tolerance for JPY weakness, it may open up inflows to capture attractive currency valuations in assets denominated in the KRW or TWD.
Despite pressure on the renminbi (Chinese Yuan), we note that based on its own trade-weighted index, the CNY is stronger year-to-date, largely due to JPY strength. If the balance of downside adjustments shifts towards the JPY up ahead, it would reduce depreciation pressure on the dollar angle.
When it comes to China specifically, what is the outlook like for asset allocation?
Policy in China is adjusting and expectations for further reflation have been boosted by news of the third plenum, which will be held in July. This is another opportunity to provide greater clarity over the direction of growth.
Read more: The impact of geopolitical events on emerging markets
Until there are clear signs of economic rebalancing taking place in China, asset allocation flows will likely also be subdued but we see no further scope for aggressive liquidation. Our ‘iFlow insights’ at BNY Mellon show that the entire allocation wave in portfolio flows pre-pandemic – especially in credit – has now largely exited and there were some additional tactical exists in equities during the pre-lunar new year round of declines in local markets.
We draw a clear distinction between underlying economic performance in China and wider emerging markets versus asset allocation performance. There is every reason to remain cautious on the former, but risk reward is highly favourable in the latter due to the dollar’s elevated valuations and lack of underlying positioning.