The Institute of International Finance (IIF) says escalating US-China trade tensions was the reason behind the capital flight from the emerging markets in the recent weeks.

The IIF, which tracks global capital flows, says trade war fears have prompted second and third-largest net outflows from Chinese equities since 2010.

“The last two weeks have produced US$5.32 billion in net outflows from Chinese equities, thanks to a deteriorating outlook in the ongoing US-China trade dispute,” the IIF stated in a note on Friday.

The Washington-based think tank adds that China is not the only market feeling the pain – the last two weeks had seen US$13.65 billion pulled from emerging markets stocks overall.

“With US-China trade and tech tensions continuing to dominate headlines and a potential US-Iran conflict brewing, policy uncertainty is a growing threat to investor confidence,” the IIF notes.

“While President Trump’s decision to delay car tariffs may offer some breathing room, repeated blows to sentiment are reflected in the whipsaw of  market movements this month: the VIX reached levels last seen ahead of the US Fed’s dovish U-turn in January; junk bond funds have seen their biggest outflows since December; foreign investors have pulled $5 billion from Chinese equities over the past two weeks; the gold price surged and US 10 year treasury yields dropped below 2.4 per cent.

“All this highlights the risk of a renewed tightening in financial conditions, with negative spillovers for the corporate earnings outlook and the macro outlook.”

According to the global capital flow tracker, some of the the abrupt swings in sentiment, and growing sensitivity to the political news flow, may also be linked to change in market structure — notably the growing role of benchmark-driven investments.

In recent years, the IIF argues, greater reliance on passive investment and the rising popularity of high-frequency trading may be making it easier for a deterioration in sentiment to feed quickly into sales of risk assets as stop-loss orders and algorithms take hold.

“Although the share of purely passive investors is still relatively small across major asset classes, the institute notes it is growing at a rapid pace as technological advances and demographic changes reshape investment habits.”

Citing the IMF, the IIF notes benchmark indices influence broadly 70 per cent of country allocations in equity and bond mutual funds via their impact on fund weights through direct, sensitivity, amplification and contagion effects — a clear example of how changing market structure can amplify price movements.

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