MANILA – The possibility of sudden emerging market (EM) financing conditions tightening is unlikely despite the recent steady rise of long-term US treasury yields, Moody’s Investors Service said, citing the current situation is different from other reversal episodes.
In a report dated Feb. 2, the debt watcher said the likelihood of “a renewed and abrupt tightening” of EM financing conditions on the back of rising US interest rates “is low for now” because it does not expect the Federal Reserve to prematurely tighten rates even with the economic recovery.
“A combination of ultra-low US interest rate and recovering US demand will in turn support EM economic and financial sentiment,” it said.
The report said US treasury yields have steadily risen since the start of this year because of expectations for an earlier economic recovery due to rollout of mass vaccination against the coronavirus disease (Covid-19) and the stimulus program of the Biden administration.
It said the yield of the 10-year US treasury traded at about 10-month highs of 11.5 percent in the middle of January 2021 while the break-even rate, or the proxy for long-term inflation expectations, of the same tenor breached 2 percent for the first time since the latter part of 2018.
In the past, any swift jumps in US treasury yields resulted in sudden reversal of portfolio inflows in EMs “as capital is diverted back into lower-risk assets.”
However, this is not expected this time because capital flows to EMs “turned sharply negative in 2020, so the starting point is much different relative to other reversal episodes.”
Citing Moody’s EM Financial Conditions Indicator (FCI), the report said economic and market sentiment on global EMs “has only just returned to historical norms following pandemic-induced stress last year.”
“Consequently, EM asset valuations do not appear overly stretched, reducing the risk of a sudden snapback in prices,” it said.
Another factor why the report considers the low probability of any sudden EM financial condition tightening vis-à-vis the recent jumps in US treasury rates is the “rising long-term yields also reflect growing market optimism around the pace of US economic recovery in the second half of 2021.”
“A stronger US economy will lift demand for EM exports and reinforce the growth rebound taking place across most major emerging economies,” the report said.
It also noted “the increase in US treasury yields –and the repricing of US interest rate expectations– is likely to remain gradual and orderly, given that US monetary authorities will likely retain a dovish policy bias even as additional fiscal stimulus is delivered.”
“Indeed, we expect the Fed to calibrate policy gradually and transparently to minimize the risk of a sudden repricing along the maturity curve, a view reinforced by its adoption of an average inflation targeting framework last year,” it said.
The report added “alongside other central banks, the Fed will also seek to ensure sufficient dollar liquidity, which will help to minimize stress in the financial markets.” (PNA)
