How Vulnerable Is Emerging Market Debt to Fed Tapering in 2022?

Swift and prudent monetary policy action in emerging markets that preceded the most recent taper announcement bodes well for emerging market debt markets.

    PREVIEW

    The announced start of Fed asset purchase tapering has left some market participants concerned that emerging markets (EM) are vulnerable to a repeat of the 2013 “taper tantrum”. In this paper, we argue that emerging market debt (EMD) as an asset class is in a stronger position to weather the tightening of US monetary policy in 2022. We observe several fundamental and technical differences compared to 2013 that contribute to this relative resilience. They include improved balance of payments dynamics in EMs and a reduced reliance on external sources of finance; less vulnerable technical positioning within EM bond markets, including via lower share of foreigner participation; and a relative reduction in EM corporate leverage. We acknowledge that the relative global growth environment is not necessarily as favorable for EMs as it was back in 2013–2014, though we observe that EM central banks have learned valuable lessons following the experience of the taper tantrum. In our assessment, swift and prudent monetary policy action in EMs that preceded the most recent taper announcement bodes well for EMD markets. Given these factors, we do not expect Fed tapering to be a catalyst for a meaningful episode of EMD selloff. The balance of risks favors hard-currency (HC) bonds over local-currency (LC) bonds, in our view.


    WHAT ARE THE RISKS?

    All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.

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    Contributors

    • Senior Vice President, Portfolio ManagerFranklin Templeton Fixed Income
    • Senior Vice President, Portfolio Manager, Research AnalystFranklin Templeton Fixed Income
    • Vice President, Portfolio Manager, Research AnalystFranklin Templeton Fixed Income
    • Vice President, Portfolio Manager, Research AnalystFranklin Templeton Fixed Income
    • Vice President, Research AnalystFranklin Templeton Fixed Income