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EM assets defy fears with third month of inflows

Emerging markets had a third month of strong inflows into their equities and bonds in February, in a further sign of reviving optimism over an asset class that was expected to be caught in the crosshairs of any US move to protectionism.

There were cross-border flows to EM assets of more than $17bn in the month, up from just over $14bn in January, data from the Institute of International Finance, an industry association, show. Of the total, $6.2bn went to EM equities and $10.9bn to EM bonds.

That puts total flows into EM assets of $43.2bn in the past three months, according to the IIF, more than reversing outflows of $37bn in October and November.

However, the latest change of sentiment among investors may not last.

“The positive economic data flow in EMs has been a significant source of support in January and February. However, we remain cautious going forward,” said analysts at IIF. “Potential headwinds — including a US-led shift towards protectionism — suggest that EM investors will be more selective this year.”

Emerging markets have started 2017 with an unexpected burst of economic growth, the IIF’s data show. Its proprietary “growth tracker” based on leading indicators such as industrial production, trade and purchasing managers’ indices from a group of EMs suggests that growth across the developing world rose to 6.4 per cent in January (see chart).

If confirmed, that would mark the fastest monthly rate of growth since June 2011 and would show the emerging world breaking out of a trend of slower growth in place since the global financial crisis of 2009-2010.

The “Trump reflation trade” — in which investors have bet on a reflation of the US economy through tax cuts and infrastructure spending by the new administration — had continued its slow unwind in February, with 10-year Treasury yields and the trade-weighted US dollar retreating from post-election highs.

Nevertheless, the IIF said, emerging market assets had continued to benefit, with hard and local currency bond yields falling, currencies appreciating and equities rising — the benchmark MSCI EM equities index, it noted, is at its highest since mid 2015.

However, its data “indicate that foreign investors have yet to take the full plunge back into EMs, opting instead for a more gradual return. In fact, flows in the final week of February were subdued, as President Trump’s first address to Congress and a hawkish tone from Fed speakers highlighted potential potholes.”

Despite the inflows from foreign portfolio investors, the IIF said, overall capital flows to EMs — including foreign direct investment and other transfers — remain strongly negative, with $168bn leaving a group of 10 countries for which the IIF has consistent data. But the outflows are caused entirely by money leaving China; for the other nine countries in the group, flows remain positive, although they have declined in the past five months.

The IIF estimated that outflows from China had eased from $67bn in December to $57bn in January following the imposition of tighter capital controls by Beijing. But it said outflows would remain “a key challenge” for authorities in China, especially if, as expected, a stronger US dollar and higher US interest rates continued to encourage Chinese people to take their money out of the country.

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