This week already promised to be a significant one for emerging markets bonds, currencies and equities with expectations in place that a formal tapering announcement will emerge after the conclusion of the Federal Reserve’s two-day meeting Thursday.
News that Larry Summers has withdrawn from consideration to be the next chairman of the Federal Reserve could spark a pre-Fed meeting bounce in major emerging markets ETFs. If the reaction of various Asian markets to Summers news is any indication, investors will be treated to at least one day of ebullience with emerging markets ETFs. [Emerging Markets ETFs Come Roaring Back]
It is believed that with Summers out of contention, President Barack Obama’s next choice to lead the U.S. central bank will be Fed Vice-Chairwoman Janet Yellen. Most Asian bourses cheered the news in Monday’s session because Yellen is more dovish than Summers. Said another way, markets prefer Yellen to be the next leader of the Fed because her policies are viewed as an extension of the ultra-loose monetary policy that is currently in place. [Bond Bulls Could Roar on Summers Fed Withdrawal]
It is that ultra-loose monetary policy from the Fed that previously boosted emerging markets bond and equity ETFs. And it is the specter of Fed tapering that has weighed on those funds along with emerging market currency ETFs so much this year. Emerging markets debt ETFs have proven especially vulnerable to tapering chatter.
While many developing countries still offer room for higher credit ratings and lower debt-to-GDP ratios than their developed market peers, investors are still not enthusiastic about the asset class. Over $3.3 billion was pulled from emerging markets debt funds in just the last two weeks of August. In the past three months, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) is off 5.4%.
Next page: Yellen and QE
“From an investor perspective, the most important thing to bear in mind is that emerging markets gain in terms of capital from accommodative policies, so on that basis Yellen would be the favorite because she is seen as less aggressive in scaling back quantitative easing,” Maarten Jan Bakkum, head of emerging markets strategy at ING investment management, told EuroMoney.
EuroMoney notes that the pace of Fed tapering could directly affect foreign investors’ appetite for emerging markets debt “with Yellen offering EM fixed-income bulls more hope.” Analysts previously argued when Summers appeared to be the frontrunner to replace Ben Bernanke, whose term expires in January 2014, that Summers was likely to ramp-up tapering. That meant the potential for inflicting even more damage on already downtrodden emerging markets assets classes and the ETFs that house them.
“In the months preceding, and immediately after a transition of the Fed chairmanship, interest rates almost always rise,” according to Bank of America Merrill Lynch Research obtained by CNBC.
Rising U.S. Treasury yields have already proven problematic for dollar-denominated and local currency emerging markets bonds. The Market Vectors Local Currency EM Bond ETF (NYSEArca: EMLC) is off 5% over the past 90 days, a time frame in which 10-year Treasury yields have spiked.
Although tapering appears to be a matter of “when, not if” at this point, the view that Yellen is not as tapering friendly as Summers could mean a near-term bounce for emerging markets ETFs.
iShares J.P. Morgan USD Emerging Markets Bond ETF
ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of EMB.