Morgan Stanley: Weak dollar and policy credibility are boosting the outlook for emerging markets.

Morgan Stanley stated that as macroeconomic, policy, and market dynamics overlap, the traditional boundaries between emerging and developed markets are gradually disappearing, with emerging markets starting the new year with new momentum. Simon Webb of Morgan Stanley said, "For investors, this convergence means that emerging market fixed income is becoming a convincing alternative to developed market fixed income. However, as this shift continues, the prices of emerging market fixed income assets are expected to continue to have a significant impact on the performance of emerging market fixed income." Webb noted that emerging market assets outperformed developed markets in emerging market sovereign credit, local currency bonds, and stocks, benefiting from the weakness of the dollar and the corresponding strength of emerging market currencies. He stated, "However, in our view, the tightening of US credit spreads and the decline in US Treasury yields are still crucial for the continued strength of emerging market spreads and local bond performance. Emerging markets have not yet completely decoupled." Following a brief period of outperformance by developed economies in 2021-22, emerging markets have once again surpassed developed economies. Morgan Stanley economists expect that spreads will continue to be a key driver of capital inflows, a situation that will persist until 2026. The reform progress in India, Vietnam, Egypt, and Saudi Arabia has increased investor confidence. Policy credibility has also increased. After the COVID-19 pandemic, emerging market central banks have gained more trust and have shown that they can act independently, proactively, and effectively in the face of shocks. Webb said, "In addition, flexible exchange rate systems have absorbed external pressures, while differences in inflation rates with developed markets have converged." However, fiscal conditions have become more imbalanced. Morgan Stanley pointed out that debt sustainability still often gives developed markets certain advantages: fiscal capacity and credibility, depth of financial markets, and lower currency risk. "This does not mean that emerging markets have not made progress, or that the fiscal situation of developed countries has not deteriorated. However, reliable analysis requires careful assessment of each country. It is clear that the current fiscal situation is a key driver of differentiation within emerging markets." Webb also noted that while cross-border capital flow into emerging markets is gaining momentum, global positions still lean towards emerging markets, with most investors maintaining moderate exposure to emerging market fixed income. Morgan Stanley currently favors local bonds in Brazil, Colombia, Hungary, and Turkey, and holds a similar position on some sovereign credits in countries such as Chile, Colombia, Guatemala, Mexico, Morocco, South Africa, and Zambia.