Morgan Stanley: A weak dollar and policy credibility are boosting the outlook for emerging markets

According to the Zhitong Finance APP, Morgan Stanley stated that as macroeconomic, policy, and market dynamics overlap, the traditional boundaries between emerging markets and developed markets are gradually disappearing, and emerging markets are entering the new year with a new strong momentum.

Simon Weaver from Morgan Stanley said, "For investors, this convergence means that emerging market fixed income is becoming a compelling alternative to emerging market fixed income. Nevertheless, as this transition unfolds, the prices of emerging market fixed income assets should continue to largely influence the performance of emerging market fixed income."

Weaver noted that emerging market assets have outperformed developed markets in terms of sovereign credit, local currency bonds, and equities, thanks to a weaker dollar and the corresponding strengthening of emerging market currencies.

Weaver pointed out, "Nevertheless, in our view, the tightening of U.S. credit spreads and the decline in U.S. Treasury yields remain crucial for the continued strengthening of emerging market spreads and the performance of local bonds. Emerging markets have not fully decoupled."

After a brief period of leading by developed economies in 2021-22, emerging markets have once again surpassed developed economies. Morgan Stanley's economists expect that spreads have been a key driver of capital inflows, a situation that will continue until 2026. The progress of reforms in India, Vietnam, Egypt, and Saudi Arabia has boosted investor confidence.

The credibility of policies has also improved. After the COVID-19 pandemic, emerging market central banks have gained more trust and have shown that they can act independently, proactively, and effectively in the face of shocks. Weaver stated, "Moreover, flexible exchange rate systems have absorbed external pressures, and the inflation differentials with developed markets have converged."

However, fiscal conditions are becoming more imbalanced. Morgan Stanley pointed out that debt capacity often still gives developed markets several advantages: fiscal capacity and credibility, depth of financial markets, and lower currency risk.

"This does not mean that emerging markets have not made progress, or that the fiscal conditions of developed countries have not deteriorated. However, reliable analysis requires careful assessment of each country. What remains clear is that the current fiscal conditions are a key driver of differentiation within emerging markets."

Weaver also noted that although the momentum of cross-border funds flowing into emerging markets is strengthening, global positions still lean towards emerging markets, with most investors maintaining only moderate exposure to emerging market fixed income.

Morgan Stanley currently favors local bonds in Brazil, Colombia, Hungary, and Turkey, and holds a similar stance on certain sovereign credits in Chile, Colombia, Guatemala, Mexico, Morocco, South Africa, and Zambia