Since the beginning of May, global fixed-income markets have sold off aggressively. The 10-year Treasury yields have increased almost 100 basis points, triggered by concerns that an improving U.S. economy would cause the Fed to gradually raise interest rates. The immediate consequence of this shift in market perception has been a sharp sell-off across global fixed-income markets.
The impact on emerging markets debt has been particularly pronounced as the fixed-income sell-off coincided with growing concern over the growth outlook in emerging markets. While gross domestic product growth in emerging markets is still higher than that in developed markets, many emerging markets have slowed over the past 24 months. In contrast, the outlook for major developed markets, especially the U.S. and Japan, remains more positive. We also see signs that the recession in the eurozone could end this year.
Concerns over growth outlook have been exacerbated by fears about capital flow reversals. The prospect for higher Treasury yields and outflows from fixed-income funds have raised the question of whether emerging markets are overly reliant on easy capital inflows. Foreign ownership of emerging markets' local bond markets has risen significantly in recent years. Meanwhile, current account deficits requiring ongoing financing have appeared or widened in several emerging markets countries. This environment has spooked many investors who are concerned that the investment case for emerging markets debt no longer works.
These fears, in our view, are excessive. Emerging markets fundamentals remain strong, and their economies are likely to benefit from a recovery in developed markets. The adjustment in valuations and technical positions is also creating investment opportunities in emerging markets debt and improving flows, going forward. However, differentiation across countries is becoming increasingly important in this environment.