France’s Woes, Brazil’s Limited Contagion Show New Emerging Era

Argentina’s finance minister had some words of caution at an annual international confab recently amid broad enthusiasm over the resilience of emerging markets. Speaking little more than a week before a rout in Brazil’s markets, Luis Caputo warned, “Just one country — one important country — getting into trouble could probably generate a systemic risk and affect all of us.”

While it’s debatable whether the surprise Oct. 25 Brazilian election result constitutes “trouble,” tumbling markets in Latin America’s biggest economy offered a test of just how solid the emerging market asset class is. So far, contagion has been limited. Even as Brazil’s assets tumbled Monday, currencies including Mexico’s and Chile’s pesos notched gains against the dollar amid a 9% plunge in Brazil’s real. Colombia sold a record batch of dollar debt.

Part of the resilience reflects work by developing nation policymakers to tame inflation and avoid unsustainable levels of borrowing. Another element gaining attention: developed nation assets don’t have the same perception of a giant margin of safety that they used to.

At the annual meetings of the International Monetary Fund and World Bank in Bangkok in mid-October — where Caputo told reporters, “allow me to be a bit skeptical” about the new emerging era — the immediate discussions around a troubled borrower were tied not to a poor nation but to a rich one: France.

“Emerging markets are no longer seen as the basket case,” said Timothy Ash, senior emerging markets sovereign strategist at RBC BlueBay Asset Management, who attended the IMF-World Bank meetings in Bangkok. “Many developed markets now compete for that label.”

The sharp September selloff in France’s sovereign debt that preceded the Bangkok gathering wasn’t the first time that a developed country’s woes captured policymakers’ attention. In 2022, it was Britain’s assets that were tumbling over concerns about unsustainable fiscal policies, just ahead of the International Monetary Fund and World Bank annual confab.

IMF Joke

Brazil’s then-central bank Governor Roberto Campos Neto even said at the time the UK crisis reminded him of his own challenges as a policymaker in an emerging market.

Natalia Gurushina, chief economist for emerging markets at VanEck, recalls a joke circulating at another IMF meeting in recent years about how the fund might need to compile an assistance package — with the usual fiscal-austerity provisions — for the largest advanced nation of them all: the US.

“It sounds like a crazy proposition, but it tells you something - the safe haven status of some developed markets is starting to be questioned,” she said.

Having gone through multiple debt crises in the 20th century, many nations in Latin America, Asia and elsewhere instituted monetary and fiscal rules aimed at cementing price stability and moderation in borrowing. When Covid triggered a surge in inflationary pressures, many — from Mexico and Brazil to South Africa — raised interest rates ahead of the US Federal Reserve.

‘More Effective’

“They’ve been much, much more effective in getting ahead of the rise in inflation — whereas developed market central banks, especially the Fed, have been cautious and much more amenable to keeping policy on hold,” said Subadra Rajappa, head of research for the Americas at Societe Generale SA.

To be clear, investors in emerging-market bonds are still requiring premiums compared with developed markets. Those denominated in dollars have returned over 12% for investors since the end of 2024, more than double that for US Treasuries. A separate index tracking local-currency sovereign debt from developing nations has gained almost 16%.

But data compiled by JPMorgan Chase & Co. shows the extra yield demanded for dollar-denominated emerging market sovereign bonds rather than Treasuries is near the lowest in almost two decades.

And in the case of local currency debt, some emerging nations’ bonds bear lower yields than Treasuries — though that exposes foreign investors to currency risk.

‘Different Paradigm’

To policymakers and investors in emerging markets, it feels like the world is upside down. “It wouldn’t surprise me to see negative spreads between EM bonds and Treasuries become more common,” Gurushina said.

Rick Rieder, BlackRock Inc.’s global fixed income chief investment officer, is among those eyeing emerging debt. With many of these nations “starting to get over the hump on inflation, then EM is an interesting way to supplement your portfolio today,” especially if the dollar stays relatively stable, he said.

“Emerging markets are on a very different paradigm than developed markets,” Rieder said in a recent Bloomberg TV interview.

Last Sunday’s shock election result from Brazil, Latin America’s largest economy — where leftist President Luiz Inácio Lula da Silva defeated pro-business candidate Flávio Bolsonaro — provided the latest test for the asset class. While the MSCI Brazil index of stocks crashed by more than 19%, the MSCI Emerging Market index lost less than 1% on Monday. The indexes closed out the week down 22% and less than 1% respectively.

Investment Bank Shift

And flows have proved resilient. Developing-nation bond funds had attracted inflows for an 13th straight week through Oct. 28, according to EPFR Global data compiled by Bank of America Corp.

Traditionally, emerging markets were thought to have three conditions. Those included relatively lower levels of per capita income, financial markets that were highly connected to the state of politics and a tight correlation between exchange rates and interest rates — where currency declines necessarily meant higher borrowing costs.

But now, says Ernesto Revilla at Citigroup Inc., only the first criterion still holds for many of these nations. The bank’s chief Latin American economist also says that “there’s no doubt advanced countries are looking more like emerging markets in some dimensions.”

Dividing the world between emerging and developed markets remains the way most investment banks are structured. “But the work those divisions do in terms of analysis, trading strategies and understanding of the economies — it just looks more similar these days,” Revilla said.