Emerging Markets Recovered Flows in July, Thanks to Bonds
International investors returned to emerging markets last month after two months of significant capital outflows. According to the Institute of International Finance (IIF), portfolio flows to emerging markets returned to positive territory in July, reaching $18.8 billion, effectively recovering the outflows from June that totaled $18 billion (over $25 billion had left in May). As has been the case in the last quarter, net flows are positive due to bets on emerging fixed income, while equities continue to experience net outflows, albeit of a smaller magnitude. IIF data indicates that flows into emerging bonds amounted to $26.7 billion, while emerging equities suffered outflows of $7.8 billion. Another distinctive feature of what happened in July was that Asian emerging markets shifted from being the main drag to the main contributor, with $9.3 billion.
The IIF's reading is that while July sends a firmer signal, it is still conditional. It highlights that demand for bonds remains broad, issuances continue to reach record figures, and the drag on equities has been reduced to a fraction of the magnitude seen in June. Looking ahead, the IIF considers that a Federal Reserve (Fed) with a more restrictive stance, coordinated intervention in the yen, and a repeated rise in geopolitical tensions only darken the outlook that has supported the reopening of the debt market. In this regard, the IIF warns that issuers have accelerated placements ahead of a possible change in U.S. monetary policy, so as August is usually a month of lower issuance levels, the next challenge for access to debt markets will be in September. In this respect, a noteworthy fact, especially for the wishes of "Toto" Caputo's team to return to capital markets: actively managed emerging debt funds recorded net inflows for the first time since 2021, and the sector's assets remain below their 2021 peak, suggesting there is room for allocations to recover rather than a saturated position.
Regarding the near future, the IIF delves into the analysis of the three forces that could test the balance of the market between bonds and equities.
- First, markets now value that there is more than a 60% probability of a rate hike as soon as September, under a more restrictive Warsh Fed, which would raise the benchmark interest rate for the duration and exchange rate of emerging markets just as issuance resumes after the Northern Hemisphere summer pause.
- Second, the recent intervention in the yen, coordinated with the U.S. Treasury, introduces a new source of uncertainty for "carry trade" operations financed in yen. A sustained appreciation of the yen would raise financing costs and could force a broader adjustment of "carry trade" positions, although the durability of the intervention's effect is still uncertain.
- Third, geopolitical tensions have shown a recurring trend of intensifying, from the Strait of Hormuz to the Red Sea, maintaining the risk of energy prices and their unequal effects on importers and exporters in emerging markets.
None of these forces have yet altered the landscape of flows, but all three operate through the same channel: lower dollar liquidity and a less permissive carry trade. Therefore, the IIF considers that July sends a firmer, yet conditional signal. "The outlook for investment flows in the Northern Hemisphere autumn will depend on whether this stabilization turns into a genuine recovery of capital flows or if it is interrupted by a Fed with a restrictive monetary policy, a stronger yen, and new geopolitical crises," notes the report by economist Jonathan Fortun from the IIF.{#p-1786574435413-25633}
What other data does the July report highlight? {#p-1786575032005-76007}
The return of positive portfolio flows from non-resident investors to emerging markets did not signify a complete normalization. The composition remained heavily dominated by bonds, and the overall improvement was more due to a decrease in equity liquidation than a recovery in equity demand.
Nevertheless, July marks a clear break in the sequence of aggregate outflows that characterized the end of the northern spring, suggesting that the tension concentrated in Asian equity markets is losing intensity rather than extending to fixed income.
Flows into emerging market bonds amounted to $26.7 billion, a figure similar to June's $28.1 billion and below last July's $36 billion. The regional distribution was again broad: Asia attracted $14.1 billion, Latin America $5.9 billion, Europe $4.6 billion, and the MENA region $2 billion. • Excluding China, flows into emerging market bonds totaled $30.1 billion, nearly the same level as in June, indicating that institutional demand for fixed income in emerging markets remained intact during July.
Sovereign issuance from emerging markets reached $19 billion, approximately double its seasonal average over the last decade, raising the gross supply accumulated so far this year to $187 billion, the highest total recorded to date, with a net issuance of around $119 billion.
The supply was almost entirely investment grade, with only $1.6 billion coming from high-yield issuers, and included large transactions from Kuwait, Chile, Hungary, and South Korea, in addition to Malaysia's first "sukuk" (Islamic bond) issuance since 2021. Euro issuance continued to expand the funding base, and frontier countries maintained access to reduced spreads.
Outflows from emerging equities decreased to just $7.8 billion compared to over $46 billion in June, when a year ago there were inflows of $10.5 billion.
Outflows from emerging equities, excluding China, fell to $4.1 billion from $32.2 billion, as the liquidation of tech assets in South Korea and Taiwan lost momentum during the month, and specialized capital funds resumed modest inflows since mid-July.
Outflows from Chinese equities decreased to $3.7 billion from $14 billion in June, while debt flows from China remained negative at $3.4 billion, extending a steady outflow that has persisted throughout the year. China's drag on the aggregate of emerging markets has been halved, but this improvement reflects lower equity outflows rather than a recovery in demand.
Regionally, emerging Asia recorded total inflows of $9.3 billion (an increase of $36.3 billion compared to the outflows of -$27 billion in June), while equity outflows fell to just $4.8 billion from $40.5 billion, and demand for debt strengthened to $14.1 billion.
Meanwhile, Latin America attracted $5.5 billion, compared to $2.5 billion in June, with inflows into bonds of $5.9 billion and equity flows of...
Emerging markets remained practically stable, in line with the strong demand for assets with high real interest rates at the end of the month.
No region recorded aggregate outflows in July, reinforcing the idea that pressure has concentrated on specific asset classes rather than affecting emerging markets as a whole. "Carry trade" strategies in emerging markets have risen nearly 12% this year, marking their best start since 2023, and this remains the focal point of the flow landscape.
The spreads on sovereign debt in emerging markets tightened to their most compressed levels in nearly two decades during July, with yields on local currencies, close to 6.2%, continuing to offer wide spreads over funding currencies, and currency volatility remained unusually low in major currency pairs of emerging markets, reducing hedging costs and favoring risk-adjusted carry trade.
Crude oil prices rose more than 20% during July due to renewed supply risks in the Middle East before retreating in early August, while yields on U.S. Treasury bonds increased. In this context, investors continued to finance exposure to emerging market debt, even as they refrained from taking risks in equities.
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-- Price
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