Global liquidity, improving investor sentiment as per our latest EM survey, and favourable technical positioning argue for a better EM outlook going into 2021. But we find three reasons to maintain our long-held selective stance: 

 Limited room for conventional monetary easing 

 Inflation risks from money supply growth, weak FX and supply chain disruptions 

 Rising fiscal worries 

We think EM policymakers are left with hard choices which include: 

 Fiscal consolidation and/or monetary tightening that could help with capital flows and/or prevent currencies from weakening further, but at the cost of growth 

 Continuation of loose fiscal policies and accommodation via unconventional monetary policy, hoping for a growth rebound and benign inflation 

 Fiscal reforms and/or an external anchor, which could help investor confidence.  

As a result, we continue to stay selective on EM as an asset class. The EM FX Strategy team argues the top-down macro backdrop is not broadly favourable yet for EM FX, though maintains a positive bias towards Asian currencies, and quality high yield currencies such as MXN, on better local dynamics. In the fixed income space, we are more constructive on hard currency debt over local currency markets. EM local bond yields have on average fallen to below pre-pandemic levels. The risks are now more tilted for higher yields with US elections-induced uncertainty, diminishing space for policy easing, and prospects of higher volatility. Low yielding EM markets provide better protection against any heightened risk aversion, we believe.  

From a regional perspective, we continue to favour Asia over CEEMEA and Latin America. From a multi-asset standpoint, we are constructive in more than one asset class in mainland China, Russia, and Mexico.  

In this report, we also take a deep dive into regional variations over the last 20 years by assessing 14 economic and financial metrics. Asia has outpaced EMEA and Latin America economically, with consequences for EM index construction, diversification and investment strategies. 

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