There are four reasons for EM risk premiums declining over the last few years and why they have now been rising even with the current improvement in EM equity markets. These are the factors that should be watched.
The four reasons that have driven the EM risk premia are:
1. The China export/import engine - it created new demand for EM markets and was an offset to the US driver.
2. Low rates in developed countries - the low to negative real rates was a boom for EM markets. Real rates are higher in the developed markets and EM real rates have followed in the same direction.
3. Internal improvement - The budget and current account deficits have been controlled and domestic inflation has been much lower than historical numbers. The recent decline in the fragile five has changed the market view on internal economics. There is more focus on each countries as opposed to the EM in total.
4. Commodity price surge -This was a great driver for EM equities. Since commodity prices have languished equities have followed.
All of these have been in a state of reversal; consequently, EM risk premiums will continue to be tilted to the upside.
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