As long as expectations about the Fed do not move too much, positive news from central banks in other developed markets can have a positive impact on overall expectations about global liquidity and the prospects for the emerging market carry trade.
Evolution of emerging market currencies since May 2013
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Monetary policy keeps global liquidity trade alive
In the past weeks, the additional monetary stimulus by the Bank of Japan (BoJ) and the high likelihood of more monetary easing by the ECB in the coming quarters have helped to keep the global liquidity trade alive. The news from the BoJ and the expectations about future action by the ECB explain why investment flows into the emerging market debt (EMD) asset class have held up reasonably well in recent weeks, despite the generally expected start of monetary tightening – i.e. a first interest rate hike – by the Federal Reserve in 2015.
In the end, the direction of the Fed’s monetary policy and US bond yields will be more important in driving investment flows to EMD than what happens in Japan and Europe. But as long as expectations about the Fed do not move too much, positive news from central banks in other developed markets can have a positive impact on overall expectations about global liquidity and the prospects for the EM carry trade (higher yields in emerging markets drive investment flows from low-yielding developed markets towards emerging markets).
Expectations for first Fed rate hike have moved forward
Since mid-October, the expectations for the first interest rate hike by the Fed have moved from November 2015 to September 2015. This is what the Fed fund futures have priced at the moment. This change in expectations, the result of somewhat better economic data, has not been dramatic enough to offset the positive news about Japanese and European central bank action. All in all, the global liquidity environment for the high-yielding EMD categories continues to look benign.