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Global liquidity should continue to increase as a number of central banks in developed markets have maintained very loose monetary policies. The Bank of Japan (BOJ) appears likely to accelerate the pace of monetary easing, with further measures to amplify accommodative monetary policy in the coming months.
The European Central Bank (ECB) recently cut rates a further 25 basis points to 0.25 per cent as the Euro Zone slowly de-leverages, and several countries within the Euro Zone face ongoing disinflationary pressures. The ECB has indicated it could take further measures.
US monetary policy In the US, comments from the Federal Reserve regarding the conditional ending of its bond-purchasing programme were inevitable, as it is not a realistic expectation for the Fed to print money indefinitely. We believe that the longer the programme continues, the longer distortions in the market could last. Furthermore, it is important to remember that the end of printing new money does not mean the end of loose monetary policy in the US.
While the Fed will eventually discontinue new purchases, and eventually even gradually raise interest rates, we believe that would still equate to fairly loose monetary policy at the global level, given the size of the Fed’s outstanding balance sheet, as well as the actions of the BOJ and the ECB. The total pool of global liquidity remains abundant and is likely to continue to expand, in our view.
We believe the fear of liquidity being pulled out of emerging markets due to the Fed eventually ending its bond-purchasing programme is overstated, as there would not be a massive contraction of liquidity out of emerging markets. Instead, we think the situation will likely result in less new money pouring into these markets.
Many emerging markets have a surplus of savings and low indebtedness. Furthermore, many of these emerging-market countries no longer rely on foreign capital inflows as they did in previous decades due to improved fiscal accounts and a large amount of foreign reserves, which can provide a cushion against capital outflows. When the Fed does end its bond purchases, the interest-rate differential will likely be in favour of emerging markets with high growth and inflation dynamics that should dictate higher interest rates than those in the US.
Fundamentals crucial The relative value potential of these countries’ assets is still intact as they have not been printing money; therefore, the exact timing of Fed tapering is unlikely to have a fundamental impact on countries that continue to exhibit strong fundamentals.
The current low levels of interest rates and the likelihood of facing a rising-rate environment are central to this near-term outlook.
We expect many emerging markets should benefit from solid fundamentals as well as ongoing capital inflows from worldwide quantitative easing. The growth prospects and low indebtedness of many emerging markets remain encouraging. Asia ex-Japan looks reasonably strong, as do select economies in Latin America and Europe. Credit conditions have remained favourable in these regions given their low levels of debt and relatively stronger growth rates.
(The author is portfolio manager and co-director of the international bond department, Franklin Templeton Investments)
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