UBS Sees Tailwinds Fade for Emerging Markets Dodging Fed Tantrum

  • Even stability in real rates will make for big change: UBS
  • EM growth narrowly based around LatAm economies, analysts say

Emerging markets will avoid a replay of the so-called “taper tantrum” of three years ago while still facing a more challenging environment in 2017 as developed economies increase interest rates, according to UBS Group AG.

“While we still don’t believe developed market real rates will rise aggressively next year, even stability stands in sharp contrast to the big declines in 2016,” strategists including London-based Bhanu Baweja and Manik Narain wrote in a report Monday. “Developed market rates will remain at very low levels, keeping a search for yield mentality alive, but without further declines we think further revaluation of emerging market assets will become harder.”

Developing nations from Brazil to Russia won’t benefit from low interest rates or a rebound in oil and they’re at risk if China’s construction growth slows, UBS said.  Emerging market government dollar bonds have handed investors an 8.1 percent return in 2016 and their currencies are set for their first gain in four years as investors pour funds into higher-yielding assets amid record-low rates. While gains have been curbed by speculation the Federal Reserve will increase borrowing costs, there won’t be a repeat of the selloff in 2013, according to UBS.

Investors pulled a record $546 million from the largest emerging-market bond exchange-traded fund last week amid mounting concern that U.S. President-elect Donald Trump’s plan to increase spending will fuel inflation and drive up U.S. interest rates, reducing the appeal of higher-risk assets. The iShares JP Morgan USD Emerging Markets Bond ETF has lost 4.7 percent since Trump’s election. The number of shares borrowed to sell the fund is close to a 13-month high.

Currencies, which are “the weakest link” among emerging-market assets, may drop as much as 3 percent versus the dollar next year, UBS said. Debt is preferable to equities on a risk-adjusted basis, while improvements in developing nation growth is predicted to be “very narrowly based” around Latin American economies.

“Owing to lower current account deficits, higher real rates and limited room for commodity prices to fall, EM is less likely to suffer a sudden stop,” the analysts said.

Should trade barriers increase after the election of Trump, who’s pledged to kill the 12-nation Trans-Pacific Partnership trade deal, economic expansion in developing nations is projected to slow to 3.4 percent from 5 percent "over the medium term," they said.

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