Capital has been leaving emerging market economies in recent weeks, but the risk of contagion to developed markets appears to be low. Excess liquidity created by very accommodative policy from the U.S. Federal Reserve in the form of low interest rates found its way to emerging markets (EM) where balance sheets for consumers and corporations were strong and yields were higher. This created upward pressure for many EM currencies which caused many of them to become less competitive abroad. In late January, the Federal Reserve continued its recent reduction in asset purchases ("tapering") which increased prospects for liquidity to recede. This had nervous investors rushing for the exits creating a liquidity squeeze. While many EM currencies had already began to depreciate last year, this deprecation accelerated resulting in countries with large current account deficits such as Turkey, India and South Africa to unexpectedly raise rates to attract foreign capital.
Many emerging markets continue to offer good value as they are growing faster than developed markets. However, all are not equally attractive and it takes a discerning approach to separate the risks from opportunities. For long-term investors, we continue to believe in a strategic allocation to emerging market equity and debt, but caution those investors with dry powder to wait for more clarity before selectively deploying capital.
Source: J.P. Morgan Asset Management, BlackRock
Author: Jason Napoli, ChFC®, AAMS®, MBA