Emerging Markets Expected to See Surge in Investor Money as U.S. Bond Buybacks Weaken Dollar

Emerging markets are likely to see a surge in investor money as they seek new opportunities after the U.S. Treasury's bond buyback plans weakened the dollar, according to analysts.

Last month, U.S. Treasury Secretary Scott Bessent doubled planned buybacks of longer-dated U.S. government debt to ease pressure on long-term yields, which surged amid concerns about inflation and debt.

Markets are looking for places to "ride out the debt bonanza," Robin Brooks, a senior fellow at the Brookings Institution, said in a post last week.

Brooks said that emerging markets are expected to see a "wall of money" as some major developed economies try to lower longer-dated government bond yields, ultimately supporting the carry trade: borrowing a cheap currency to invest in higher-yielding assets.

The greatest risk for carry trades, a sudden spike in borrowing costs, has been diminished due to the U.S. government's involvement, he said.

Global emerging market bond funds recorded inflows of $967 million in the week to Wednesday, up around 15% from the previous week, even as inflows into bond funds overall slowed, according to TD Securities data.

Gold prices have also gained from Bessent's intervention as investors seek safe havens, with Deutsche Bank and Bridgewater Associates founder Ray Dalio among those backing the precious metal.

Treasury's announcement signaled to the market that "the U.S. could potentially engage in policies which are akin to financial repression," said Peter Kinsella, global head of FX strategy at Union Bancaire Privee in London. "This resulted in a weaker USD, and high-yielding G10 and EM currencies benefited."

The South Korean won strengthened 2.83% against the dollar since Bessent's bond buyback announcement, according to LSEG data. The Brazilian real gained 0.64%, and the South African rand 0.59%.

The broader environment for carry trade outperformance, such as low volatility and broadly falling inflation, remains "firmly in place," Kinsella said.

Brazil and Turkey are favored in emerging markets, as they continue to flaunt high levels of nominal and inflation-adjusted yields, he said. In the G10, the currencies of Australia and Norway are favored, he added.

Brazil has one of the highest inflation-adjusted interest rates among major economies. Its benchmark interest rate stands at 14%, with a 12-month inflation of 4.2% as of mid-August.

Turkey's central bank left the one-week repo rate unchanged at 37% in July, though the country's annual inflation stood at 31.75%.

Wee Khoon Chong, macro strategist for Asia Pacific at BNY in Hong Kong, said Colombia has been "very popular" for carry trades this year.

That country's currency was up around 20% in the year-to-date through Friday, and the benchmark stock index COLCAP was up around 20%.

Asian currencies, on the other hand, are expected to continue to underperform their EM peers, Eric Robertson, chief strategist at Standard Chartered Bank, told "Squawk Box Asia" on Monday. That makes Asian currencies less desirable target investments.

Asian currencies tend to offer lower implied yields than other currencies, a pattern that will likely remain unchanged if the Federal Reserve is heading for a hike, he said.

India's central bank has one of the highest key interest rates in Asia at 5.25%, almost a third of Brazil's.

Dollar-funded carry trades are just getting underway, given that emerging markets have seen "massive outflows" due to the Iran war, Brooks said.

He added that the Treasury's bond buyback announcement suggests that over time there could be more measures "in more places with ever greater intensity."