BlackRock’s emerging market debt ETF topped outflows last week as the Federal Reserve brought forward its interest forecasts by signalling at least two hikes before the end of 2023.

According to data from Ultumus, the iShares J.P. Morgan $ EM Bond UCITS ETF (JPEA) saw $377m outflows in the week to 18 June, the most across all ETFs listed in Europe.

This followed the most recent Federal Open Market Committee (FOMC) meeting, in which delegates voted to keep short-term borrowing rates at 0% but decided to bring the previous rates increase timeline forward by a year, from 2024.

Some seven of the 18 FOMC members now see at least one interest rate hike in 2022 while 13 predict predicting it before the end of 2023.

The latest signals from the Fed come after US inflation surged 5% year-on-year in May, the fastest pace of growth since 2008, putting pressure on the central bank to tighten monetary policy in the near term.

Although somewhat expected, the hikes signal had an adverse effect on equities at the end of the week, with the S&P 500 shedding 1.5% in the 24 hours following the meeting.

Crucially, the announcement has implications for debt markets. As interest rates increase, they push yields on US bonds higher which attracts more investment from overseas investors.

The knock-on effect of this is an impact on the exchange rate, in this case strengthening the US dollar.

Because of the increase in purchasing power of the US dollar relative to their domestic currencies, policymakers in emerging markets will be more reluctant to take on debt denominated in US dollars to finance programmes such as fiscal stimulus.

Investors exit short-duration bond ETFs as European Central Bank strikes dovish tone

Illustrating the power of this dynamic, while JPEA topped outflows last week, the SPDR Barclays Emerging Markets Local Bond UCITS ETF (SYBM) collected $69m inflows over the same period.

Unfortunately for emerging market countries relying on US dollar-denominated debt, Fed rates hikes can have a vicious cycle effect. On the one hand, it attracts capital flows into the US – and away from emerging markets – which makes it harder for emerging market companies and governments to service their US-denominated debt.

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