Despite rising US yields and geopolitical risk, EM credit spreads have remained stable. This resilience stems from the perception that the global growth cycle is still strong. As long as rising yields reflect economic activity, investors are attracted to the high all-in yields, which supports credit markets.
The market has already priced in the hawkish Federal Reserve. The most recent volatility and sell-off in emerging market rates are not driven by US monetary policy but almost entirely by soaring energy prices and the geopolitical uncertainty surrounding them.
Beyond traditional factors like carry, a new driver is differentiating performance in mid-yielding emerging market currencies. Markets are now closely scrutinizing whether central banks are turning hawkish or dovish, and this policy stance is becoming a primary determinant of currency strength or weakness.
Initially, the rate sell-off was driven by a pro-cyclical growth outlook, causing lower-yielding markets to underperform. Now, as high energy prices hurt risk appetite, the pressure is shifting to higher-yielding, high-beta markets, indicating a potential tipping point in market dynamics.
Unlike local rates, the EM FX market has been less volatile amid recent geopolitical escalations. A key technical reason is that very little capital was positioned in the asset class to begin with, meaning there were fewer positions to be squeezed out, thus dampening the market's reaction.
The Israeli currency has been trading weakly, influenced by a dovish central bank and tech sector sentiment. However, this price action appears to ignore strong underlying fundamentals, such as a meaningful pickup in Foreign Direct Investment (FDI) and a robust basic balance, suggesting a potential market mispricing.