Investors pulled money from emerging market bonds and stocks at the fastest pace since March 2021 as fears over tightening monetary policies, economic recovery from the pandemic and geopolitical frictions worsened outlook.
Foreign investment in emerging market stocks and bonds outside China has come to an “abrupt standstill”, the IIF said in its January capital flows tracker report on Friday.
“We believe that the outlook is worsened by the Omicron variant and expectations of higher US interest rates,” the report said.
“Overall, the first month of the year has seen increased volatility in markets, pushing investors out of emerging market securities.”
Rising inflation is a major concern for policymakers across the emerging markets landscape, with 18 of 20 major central banks tightening monetary policy, which consequently curbed bond flows. The annual rate of inflation in the euro zone spiked to 5.1 per cent, figures released earlier this week revealed. US inflationary data, which will be released on February 10, is also expected to show that core prices (excluding energy) grew 5.9 per cent annually in January.
“Market jitters in developed market equities have spilled over and we see emerging markets, excluding China equities, with outflows of $3.2bn,” the IIF report said.
Non-China emerging debt suffered an outflow of $4.5bn, despite good performance of local currency bonds across many markets.
However, bonds in China received $9bn in flows last month on the back of policy measures from the country’s central bank. The China and non-China emerging market split is “rooted” in growth with the world’s second largest economy expected to rebound more quickly.
“Moving forward we see greater differentiation on flows dynamics, as some countries have bottomed up and could potentially benefit from higher commodity prices and potential dovishness from central banks. However, if market volatility persists, the outlook could worsen,” the IIF said.
Separately, the Washington-based institute said the US economy is almost back to its pre-pandemic growth trend, with a much faster rebound than after the global financial crisis, an outlier compared to the other G10 economies.
The IIF also flagged a weaker recovery in the euro zone, where the picture for consumption and investment looks less compelling.
“Nowhere in the euro zone has private consumption recovered as much as in the US,” it said. “Consumption levels remain especially depressed in Italy and Spain.”
The European Central Bank on Thursday made a policy turnaround, acknowledging mounting inflation risks and opened the door for a potential interest rate increase this year.
ECB President Christine Lagarde said that while inflation is likely to remain elevated for longer than previously expected, it will decline over the course of this year.
However, compared with expectations in December, risks to the inflation outlook are tilted to the upside, particularly in the near term as the “situation has indeed changed”, she told a news conference.
While Ms Lagarde said the ECB would not rush into any move, she declined to repeat her previous guidance that an interest rate increase this year was "very unlikely".