Flows into emerging market bond funds fell in the week to March 11, and inflows to emerging market equity funds flattened after five straight weeks of net purchases, market observers said on Friday. The change in investor behaviour followed the outbreak of hostilities in Iran and a sharp rise in oil prices, which together have increased uncertainty around risk assets.
Analysts said the conflict has prompted a re-evaluation of risk exposure. "EM credit had been remarkably resilient to the AI disruption-driven gyrations in broader risk markets in February," Andreas Kolbe, head of EM credit research at Barclays, wrote in a note. "But recent events in the Middle East, and the associated spike in energy prices, have quickly shifted the narrative from a 'goldilocks'-type environment to stagflation." He was referring to the earlier view that emerging markets benefited from a weaker U.S. dollar, post-COVID-19 reforms in several countries and prudent central bank policy - conditions that now could be undermined by the mix of slowing growth and higher inflation.
Data compiled by EPFR and cited by market strategists showed that outflows from global-mandated emerging market funds reached $1.1 billion in the past week, following inflows of $3.2 billion in the prior week, according to Morgan Stanley analysts. That reversal came amid broad flight-to-safety moves across investor portfolios.
Despite the recent reversal, some market participants highlighted the scale of earlier inflows. Matt Vogel, head of emerging markets strategy at Marex, noted that EPFR figures record a year-to-date high of $21 billion flowing into emerging market debt funds so far this year, underscoring that the asset class had attracted heavy investor interest prior to the latest turbulence.
Emerging market assets had been enjoying an extended rally in which stocks, bonds and currencies outperformed expectations. Central banks across developing nations had been showing signs of growing optimism about global economic resilience and easing price pressures, prompting talk of an eventual easing cycle among some policymakers. Those plans, however, have been interrupted by the recent developments in the Middle East.
Market nerves have been heightened by the lack of a clear endgame to the conflict and by statements from Iran's new leader vowing to keep the Strait of Hormuz - a vital route for global shipping - closed. Those factors have left investors reassessing both near-term growth prospects and inflation risks for countries exposed to energy price swings.
Citi analyst Luis Costa summed up the cautious view among some investors: "We maintain a cautious stance on emerging market assets due to significant headwinds," he wrote, adding: "it will all depend on the longevity of this energy price squeeze." The trajectory of energy prices and the persistence of geopolitical tensions will therefore be major determinants of whether the emerging market rally can resume.
Market context and implications
- Bond and equity flows to emerging markets shifted as geopolitical risk intensified and oil prices rose.
- Previous optimism among EM central banks and investors about easing price pressures has been interrupted by renewed uncertainty.
- Large year-to-date inflows into EM debt funds—recorded at $21 billion—provide a backdrop to the recent pullback, showing how quickly sentiment can reverse.