Has quantitative easing (QE) among developed nations’ central banks benefited emerging markets (EM)? While it seems very intuitive to answer “yes,” our EM strategists believe the interaction between G7 QEs and EM financial markets and economies has been much more complicated. In fact, this relationship resembles a love-hate story.
On one hand, G7 QEs has depressed yields on their local domestic fixed-income securities, encouraging global investors’ “love” toward EM. Consequently, substantial capital has flown from the G7 into EM. On the other hand, EM risk assets – stocks, currencies and credit markets – have performed very poorly, despite ongoing and rotating QEs within the advanced countries.
Many investors have been disappointed by EM’s broad-based poor performance. As for EM policymakers, back in 2009-’10 they struggled to contain massive portfolio inflows. Now, a number of them are struggling with outflows. Both issues – investors’ disappointments with EM asset performance and EM policymakers’ travails managing the torrential inflows/outflows – reflect the “hate” aspect of the interactions between QEs and EM.
The reason why EM risk assets have done poorly despite the ongoing QEs is their indigent fundamentals in general and sharply deteriorated return on capital. Capital inflows related to QE led to overinvestment and mal-investment in EM, which is now weighing on profitability.
By and large, odds are low that the ECB’s QE will be very different from the previous QEs with respect to its impact on EM; it could produce short-term bounces in EM, but the cyclical outlook for EM risk assets remains downbeat.