ECB's QE will buoy EM bond markets

Subject

Opposite forces are shaping investor sentiment towards EM assets.

Significance

Investor sentiment towards emerging market (EM) assets is being shaped by the conflicting forces of a strong dollar and the launch of a sovereign quantitative easing (QE) programme by the ECB. While the latter is likely to encourage investment into higher-yielding assets, such as EM debt, the former will keep the currencies of developing economies under strain, particularly those most sensitive to a rise in US interest rates due to heavier reliance on capital inflows to finance large current account deficits, such as Turkey and South Africa.

Impacts

• EM bonds will benefit from ECB-related inflows, while the strength of the dollar will keep local currencies under strain.
• Higher-yielding EMs will benefit the most from the ECB's bond-buying scheme since they provide the greatest scope for 'carry trades'.
• The collapse in oil prices is forcing EM central banks to turn increasingly dovish, putting further strain on local currencies.