U.S. Disarray Has Emerging Markets Struggling to Hold the Line

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Staring down almost $16 trillion of negative-yielding debt worldwide, investors will continue to be drawn to the higher returns offered by emerging-market assets and the prospect of an economic recovery next year, analysts say. Developing-nation currencies are also benefiting from broad dollar weakness, with the U.S. currency still below its 200-day moving average. Trump’s diagnosis has also made it more likely Congress and the White House will reach a deal on pandemic relief before the November election.

Against that backdrop, the benchmark emerging-market currency gauge climbed 0.5% in the five days through Friday, led by the South African rand and Mexican peso. MSCI Inc.’s gauge of stocks gained 2.1%, its best week since August, and the Bloomberg Barclays (LON:BARC) index of local-currency bonds added 0.4%. Dollar bonds were steady after a three-week sequence of declines.

“We try and zoom out from the current noise around U.S. politics and the potential for a U.S. fiscal stimulus package,” said Anders Faergemann, a London-based senior money manager at PineBridge Investments, which manages about $104 billion. “The recent market wobble represents an opportunity to reposition for a constructive outlook for emerging markets into 2021.”

Still, last week’s revelation that Trump tested positive for the Covid-19 coronavirus will likely keep risk appetite in check. New disclosures about his treatment raise concern that his condition is more serious than what the American public has been told. Emerging-market stocks, currencies and dollar bonds were stronger on Monday following news Trump may be released from hospital soon.

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Emerging-market investors may be on their way out amid uncertainty surrounding the U.S. election, the Institute of International Finance warned last week. While investors poured $12.9 billion of net non-resident portfolio flows into emerging-market bonds in September, they withdrew about $10.8 billion from equities, and the divergence between debt and equity flows is rising, according to the Washington-based trade group for financial institutions.

“Our data shows that a big ‘risk-off’ is brewing in emerging markets,” IIF economist Jonathan Fortun wrote from Washington. “We are tracking high-frequency outflows from EM in the final weeks of September almost as big as in the 2013 taper tantrum.”

After last week’s acrimonious U.S. presidential discourse, this week’s vice-presidential debate between Democratic nominee Kamala Harris and Vice President Michael Pence on Wednesday will be in focus as there could be an orderly discussion of issues.

There are also country-specific factors to consider. Argentina’s investors will be keen to see the impact of central bank measures that allow the peso to depreciate faster. While Turkey’s lira rose on better-than-expected consumer price data, core inflation — which strips out volatile items such as food and energy — pushed higher, a sign that some of the underlying cost pressures may be increasing.

“Both Argentina and Turkey are facing challenging times with declining FX reserves, but the market considers these events idiosyncratic,” Faergemann said. “We don’t expect those concerns to spread to other emerging-market countries.”

Investor anxiety, as measured by implied volatility for developing-nation currencies, eased by the most in three months last week, according to a JPMorgan Chase (NYSE:JPM) & Co. index.

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