London. A flood of cheap money in the global banking system being pumped by developed central banks is reshaping the investment landscape as the dollar plunges and capital chases higher yields in emerging markets.
The Federal Reserve’s promise to print more money to shore up the US economy, Japan’s yen-selling intervention and calls for more monetary easing in Britain have all but ensured interest rates in advanced economies will stay near zero for some time.
In the past week, those expectations have knocked the dollar to six-month lows, sending gold to record highs.
The yen approached levels where Japan officially intervened, stirring talk of more action - which in turn would pump more cash into the system.
With returns on investment staying low in advanced markets, large amounts of cash are pouring into emerging economies.
Emerging stocks, measured by MSCI, hit their highest level since July 2008 in the past week, as their correlation with US stocks hit a 14-month low.
Emerging equity and bond funds have attracted nearly $80 billion in inflows this year, surpassing last year’s total, according to data from fund flow tracker EPFR.
The Institute of International Finance expects broader flows into emerging economies to exceed $700 billion.
This means the “risk-on risk-off” mentality that dominated much of the post-crisis market is waning and lines are getting blurry between emerging and advanced economies.
“Emerging markets have graduated. We are moving into the world where a difference between advanced and emerging markets is becoming less important,” said Piero Ghezzi, head of economics research at Barclays Capital.
“It’s going to be a long time before any of the G4 countries will start tightening. Carry is going to play a larger role. When volatility is low, risk-adjusted carry is more attractive.”
Barclays sees Advanced Emerging Markets as a new asset universe that would attract significant capital flows.
The make-up of developed and emerging markets may be changing too.
The index compiler FTSE has just left Greece on its watch list for a possible downgrade to AEM. If implemented, the move could prompt an exodus by index-tracking funds.
“It is not just the shorter-term dynamics that favor emerging countries at the moment,” said Bill O’Neill, chief investment officer for Europe, Middle East and Africa at Merrill Lynch Wealth Management.
He said the emerging market middle class - expected to reach 1.5 billion by 2030 - will drive purchasing power and domestic demand. Investment in power, water and other infrastructure should exceed $20 trillion over the next decade.
A wave of liquidity comes as the global economy is expected to expand at 4.6 percent this year, with some emerging economies growing at nearly 10 percent.
With the level of fiscal debt, Credit Suisse estimates there is $6.2 trillion of excess leverage in the developed world.
This would eventually stoke inflation in the long term, which would also help debt-laden governments reduce their fiscal deficits. Inflation-proof assets such as equities, gold and inflation-linked bonds would then outperform.