China-driven growth seen helping emerging assets despite bank worries

Stronger Chinese-led emerging markets growth will likely buffer the stocks, bonds and currencies of many developing nations as markets in the United States and Europe are whipped around by banking turmoil.

But weeks of volatility in global markets, spurred by bank failures, rescues and emergency government assistance, could knock vulnerable emerging economies, strategists said, necessitating careful picks.

"The growth premium in favour of emerging markets driven by China is clearly even more confirmed," Alessia Berardi, head of emerging markets (EM) research at Amundi, Europe's biggest asset manager, told Reuters.

Analysts expect high interest rates, inflation and stress among some financial institutions to dampen growth in developed markets like the United States.

The US Federal Reserve raised rates by a quarter point last week, but signalled it could pause hikes and some analysts expect it to cut later this year as the economy slows.

Jonny Goulden, head of EM local markets and sovereign debt strategy at JPMorgan, noted the risk premium on EM bonds had risen amid the wider pressures, but the fallout had so far been limited.

"As fixed income returns have been cushioned by rates markets that have priced Fed cuts later in the year, EM has had few signs of real stress," Goulden said in a note to clients.

Many of the world's top central banks are openly contemplating an early end to rate hikes, not least because of the recent financial turmoil.

This could pave the way for EM policymakers to start reducing interest rates, supporting growth.

BlackRock, the world's largest asset manager, switched to an overweight rating on EM local debt last week, from neutral previously.

"We prefer income in emerging markets debt with central banks closer to turning to cuts than developed markets, even with potential currency risks," it said in a research note.

Local EM bonds have seen a return of 3.3% in the month-to-date (.JGEGDCM), compared to a 3.1% gain in US 10-year Treasuries.

Attractive local debt valuations in Brazil, Columbia, Peru and Mexico offer good opportunities over the next six months, Amundi's Berardi said, while currencies call for more caution.

STELLAR START FIZZLES OUT

The re-opening of China's economy at the start of this year, following three years of COVID-19 lockdowns, sparked a strong rally in emerging assets.

While gains have been more muted recently, the MSCI's EM equities index (.MSCIEF) is on track for a 2% gain in March, outperforming pan-European stocks (.STOXX) and a touch above the US S&P 500 (.SPX).

EM investors are increasingly positive and sentiment is expected to be sustained into the second quarter, a survey of more than 100 EM investors by HSBC just before the banking turmoil showed.

Some of the momentum comes from domestic conditions in individual markets, said Juliana Hansveden, portfolio manager for EM sustainable equities at Ninety One, a global investment manager.

"A quarter of the world's population is unbanked and most of those people live in China, India, Mexico etc," she said.

But others were more pessimistic - especially on the outlook for emerging economies with lower credit ratings or already in debt distress.

Currently, the risk premium on bonds issued by 18 emerging economies in JPMorgan's EMBIG hard currency index stands more than 1,000 basis points over US Treasuries, effectively shutting them out of international capital markets. Those include countries that have defaulted on debts such as Sri Lanka and Zambia, but also the likes of Egypt and Pakistan.

At the start of 2022, that number stood at nine.

The banking sector troubles have compounded the problems of already-struggling EM countries, said Frank Gill, one of S&P Global's top sovereign analysts.

"It's not a great time to price a bond if you are a BB or a lower B (rated country)," he said.