EM FX:EM Flows and Risk Sentiment in the context of North Korea risks

In this report, we provide an update of our EM Flow Indicator, a tool to track flows into emerging markets that combines normalized weekly flow data from two sources - IIF and EPFR - and incorporates both local currency debt and equity flows. We also update our complementary EM Risk Monitor, which is a multi-dimensional, EM-specific measure of risk sentiment.

    Summary of results: The EM Flow Indicator shows that there were EM outflows for the first time this year in the week following 10th August; this was driven by the spike in US-North Korea tensions. However, these outflows lasted for only one week, with inflows into EM resuming the following week. This highlights the resilience of broader EM, and the limited spill-over/follow-through of geopolitical tensions. It also provides a rough template for the potential impact of the current North Korea-related risks (which have again spiked over the past few days) - as long as there is no escalation from the current situation (admittedly still an open question), the spill-over/follow-through to broader EM is once again likely to be limited, and EM inflows should continue as the rest of the external environment remains supportive (weak dollar and contained US rates). Meanwhile, the EM Risk Monitor - an EM-specific measure of risk sentiment - is in risk neutral territory (i.e. risk sentiment is not stretched), hence indicating scope for improvement and also for continued EM inflows.

    The EM Flow Indicator (chart below) has moved back to positive territory (indicating inflows), after a temporary dip into negative territory in the week following 10th August; the outflows during that week were driven by the spike in US-North Korea tensions, for example President Trump’s ‘fire and fury’ remarks. The fact that EM outflows were very short-lived (1 week) and the inflow trend resumed quickly highlights broader EM’s resilience to, and limited spill-over/follow through from, geopolitical risks. The latest weekly signal (covering data up to 23rd Aug) is +0.3, which implies robust - but not extremely strong - inflows. Note that the indicator captures flows normalized by the standard deviation, with values greater than +0.5 indicating sizable inflows and values less than -0.5 indicating sizable outflows. The recent flow performance also provides a rough template for the impact of the current North Korea-related risks (which have again spiked over the past few days) - as long as there is no escalation from the current situation (admittedly still an open question), the spill-over/follow-through to broader EM is once again likely to be limited, and EM inflows should continue as the rest of the external environment remains supportive (weak dollar and contained US rates).