Growing concern over stricter monetary policies in the United States among investors in developing nations
Headline: Emerging Market Investors Adopt Cautious Optimism Amid Improving Fundamentals
Emerging market (EM) investors are displaying a cautious but optimistic stance, as indicated by their cash holdings and deployment expectations over the next three months. This shift is driven by recent strong performance, currency dynamics, and macroeconomic factors.
Key Trends and Reasons
The first half of 2025 has seen EM assets, including equities and fixed income, deliver their best returns in decades. This surge was fueled by the sharp weakening of the US dollar and currency appreciation in EM local debt markets, with Latin American EM credit markets notably benefiting from local currency strength and bond market recovery[1].
Investors typically maintain elevated cash positions during periods of underperformance and volatility, acting as a dry powder to be deployed opportunistically. The improved fundamentals and recent rally have increased deployment expectations in the near term, as investors aim to capitalize on potential further gains[1][5].
Central banks in key EM regions like Latin America are better positioned to ease monetary policy amid disinflation and a weak US dollar, which supports growth prospects and encourages investment deployment. However, EM equities face challenges competing with US growth fundamentals, suggesting a nuanced deployment favoring fixed income and selective equity exposure[1].
Impact on EM Assets
The combination of a soft US dollar, improving EM fundamentals, and monetary easing is expected to support EM asset prices. Fixed income, particularly local currency debt, has strong chances for attractive risk-adjusted returns[1][3].
Despite some outflows in global equity funds recently, these flows included world stocks broadly rather than exclusively EM assets. Recent EM market rallies imply that portions of investor cash reserves are being allocated back into EM markets, contributing to positive price momentum[4][5].
Additional Findings
- 59% of investors have revised down their inflation expectations, reflecting a more positive outlook on EM economies[2].
- Risk appetite, measured on a scale of 0 to 10, increased slightly from 6.04 to 6.17, indicating a slightly more optimistic view[2].
- About half of investors view the outlook for emerging markets as neutral over the next three months, while Asia remains the most popular investment destination[6].
- Climate change, inequality, and the protection of minority shareholders remain the top three ESG themes, with 45% of respondents having directly or indirectly aligned their portfolios with ESG, an increase from 30% in the previous year[7].
- 40% of respondents expect emerging market currencies, particularly those in Russia and Brazil, to appreciate against the US dollar[8].
- 40% of investors are optimistic about the outlook for emerging markets over the next three months, down from 89% at the end of last year[9].
- When concerned about rising global interest rates, investors look for a higher risk premium to protect against tapering[10].
- Investors are most optimistic about countries that are raising interest rates[10].
- The HSBC survey on sentiment in emerging markets was conducted between June 8 and July 23 and included 124 investors from 119 institutions managing a combined $506 billion in emerging market assets[11].
In summary, EM investors have maintained significant cash positions but are increasingly deploying capital in anticipation of sustained EM asset outperformance, underpinned by currency movements, easing monetary policy, and improving regional fundamentals. This behavior is likely to keep EM assets supported over the next few months.
[1] Source: Bloomberg [2] Source: HSBC Global Emerging Markets Survey [3] Source: JPMorgan Chase & Co. [4] Source: Bank of America Corp. [5] Source: Goldman Sachs Group Inc. [6] Source: Financial Times [7] Source: PwC [8] Source: Reuters [9] Source: Bloomberg [10] Source: Barclays Plc [11] Source: HSBC Global Emerging Markets Survey
- The improving fundamentals in emerging markets have led many investors to adopt a strategy that balances caution with optimism, using their cash holdings for opportunistic investments in both equities and fixed income within the finance sector, as part of their broader business strategies.
- As emerging market assets continue to perform well, with strong profits in equities and fixed income, finance professionals are increasingly investing in these markets, recognizing the attractive risk-adjusted returns offered, particularly in local currency debt, for their insurance portfolios.
