While emerging markets bonds, equities and currencies have bounced back a tad from the recent selloff, their best days are now over, Capital Economics said in a note on Thursday.
For both emerging-market dollar and local-currency bonds, Capital Economics expected yields would rise in the next couple of years.
”In our view, tighter monetary policy in the U.S. will cause ‘risk-free’ rates to climb a little further in the near term. And we think that credit spreads will widen as investors lose their appetite for risk,” the note said.
Capital Economics didn’t expect that U.S. Federal Reserve tightening would be a big deal for most emerging market currencies between now and the end of 2019, pointing to healthier current account balances now compared with during the taper tantrum a few years ago.
“But we expect them to weaken regardless,” the note said, citing three reasons.
Investors to ‘lose appetite’
Firstly, it said it expected overseas investors would lose their appetite for emerging market assets. Secondly, many emerging markets currencies still track commodity prices, such as the close ties between Russia’s ruble and oil prices, Capital Economics said, noting it forecasted commodity prices would fall.
The final reason was politics, Capital Economics said, citing the risk of U.S. protectionism, with currencies acting as a “safety valve” to help offset any possible loss of competitiveness.
For emerging market equities, the note said the forecast was for the MSCI Emerging Market index to be “well below” its current level at the end of 2019. It set a target of 1220 for the index at end-2018 and 1070 for end-2019, compared with current levels around 1210.