Don’t Look Now, But Something Cracked On Tuesday

One of the questions we’ve been asking for some time now is this: “when will emerging markets finally start to crack?”

Indeed it was just two days ago when we penned “It’s ‘Make-Or-Break Time’ And We Could See ‘A Painful Cleanout,’” a post which (probably thanks in large part to the ambiguous title) became one of the most popular pieces we published all week.

You’ll recall that EM has been remarkably resilient in the face of what’s supposed to be a Fed tightening cycle.

EMPerform

(Deutsche Bank)

This is probably attributable (at least in part) to dollar weakness in Q1 and Treasury yields exhibiting a penchant for declining at the first sign of trouble. As long as the Treasury rally is viewed through the lens of the market rendering its judgement on the Trump administration’s inability to get anything done, it’s probably supportive for EM flows but should falling yields begin to be interpreted as a risk-off move, well then it becomes a problem. Here’s how Barclays explained it earlier this week:

In the current context of persistent flows into EM, lower US Treasury yields should be supportive of EM returns; however, if lower UST yields begin to reflect a broader ‘flight to safety’ against a backdrop of more mixed signals from the latest economic data, an increase in geopolitical tensions, and European election risks, this would be more worrying for EM assets.

Right.

Well don’t look now, but we may have seen the first sign that things are rolling over because on Tuesday, the iShares EM local currency bond ETF, saw $82.6 million in outflows, the second biggest exodus on record.

Or, visually…

Outflows

Do note that the last time we saw these kinds of outflows was early last year or, for those who need a refresher, “around the time when China jitters led directly to a horrific January and the world was fast sinking into the deflationary doldrums.”

As Bloomberg writes, “the withdrawals from the $250 million fund come the day after the Trump administration’s opening salvo on trade issues, which saw tariffs levied against imported Canadian softwood lumber.”

Trade accordingly.

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