Drivers of Emerging Market Bond Flows and Prices
Global Financial Stability Notes, December 16, 2021
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Bibliographic details
- Authors: Evan Papageorgiou, Rohit Goel
- Published: December 16, 2021
- Series: Global Financial Stability Notes
- DOI: https://doi.org/10.5089/9781616357597.065
Key findings
- A disconnect has developed between local currency- and hard currency-denominated bonds in emerging markets since the start of the recovery from the COVID-19 pandemic.
- Emerging market assets recovered sharply from the COVID-19 sell-off in 2020, but the post-pandemic recovery in 2021 has been highly uneven.
- Yields of local currency-denominated bonds have risen faster and are approaching their pandemic highs.
- Hard currency bond yields are still near their post-pandemic lows.
- Portfolio flows to local currency debt have lagged flows to hard currency bonds.
- The disconnect is closely linked to the external environment and fiscal and inflationary pressures.
- Local currency assets are significantly more sensitive to domestic fundamentals.
- Hard currency assets are dependent on external risk sentiment to a greater extent.
- Post-pandemic, stressed domestic fundamentals have weighed on local currency bonds, partially offsetting the boost from supportive global risk sentiment.
- The analysis highlights risks from an asynchronous recovery and weak domestic fundamentals for emerging markets.
Methodology and modeling insights
- The note draws from the methodology developed in earlier Global Financial Stability Reports on:
- fundamentals-based asset valuation models for funding costs; and
- forecasting models for capital flows using the at-risk framework.
- Results are consistent across models, supporting the differentiation in drivers for local versus hard currency assets.
Implications for policymakers and investors
- Evolution of the disconnect between local and hard currency markets remains a key consideration because local markets are the main source of funding for emerging markets.
- Policymakers should monitor domestic fundamentals (including fiscal and inflationary pressures) given their larger influence on local currency assets.
- Investors should account for greater sensitivity of hard currency assets to external risk sentiment when allocating across emerging market bond types.
Risks and considerations
- An asynchronous global recovery can exacerbate divergence between local and hard currency bond performance.
- Weak domestic fundamentals can transmit to higher local currency yields and reduced portfolio flows into local debt, constraining domestic funding conditions.
Source: "Drivers of Emerging Market Bond Flows and Prices", Global Financial Stability Notes, December 16, 2021.
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