LONDON (Reuters) - Emerging market currencies and stocks hit multi-month highs on Tuesday, shrugging off an escalation in tensions between Russia and Ukraine thanks to a renewed interest in high-yielding carry trades and expectations of stimulus from China.
Russian stocks fell to 10-day lows but even the rouble rallied almost half a percent as investors flocked to a range of emerging assets from sovereign dollar bonds to formerly shunned currencies from the 'Fragile Five' countries - Brazil, Indonesia, India, Turkey and South Africa.
MSCI's emerging equity index rose half a per cent to nearly four-month highs, thanks to a 2.2 per cent gain in shares in China, where investors are increasingly pricing in some form of stimulus to boost flagging economic growth.
The emerging index was up for the third straight day despite steep falls on Wall Street, where the Nasdaq has suffered its worst three-session fall since November 2011, and potentially destabilising events in eastern Ukraine.
Pro-Moscow protesters seized arms in one Ukrainian city and declared a separatist republic in another, moves that Kiev has described as a Russian-orchestrated plan to justify an invasion.
"The events are worrying from a long-term perspective but for the time being, unless we see a massive escalation of tensions, markets will simply ignore it," said Abbas Ameli-Renani, a strategist at RBS in London.
Ameli-Renani said a stronger factor for the market mood was investors' new-found keenness to build positions in beaten-down emerging markets, especially given renewed interest in high-yielding carry trades and smooth elections in Turkey and Hungary.
"There is no appetite to be more bearish on emerging markets. It's going to be difficult to get positive returns by being bearish on EM," he said.
"We saw profit taking on short EM positions but positioning still favours more emerging market gains because of the carry that's being offered."
The carry trade - the practice of selling low-yield currencies such as the euro for higher-yielding assets - has gained traction in recent weeks as implied volatility - currency price swings - has fallen.
On currency markets, the lira and rand hit three-month highs to the dollar while the Brazilian real is trading at 5-month highs.
Earlier in Asia, the Indonesian rupiah rose slightly after the central bank left interest rates on hold as expected but the currency is up more than 7 per cent so far this year. The ringgit and Singapore dollar hit four-month highs.
Indian markets, where the rupee hit eight-month highs recently, were shut.
"Surplus liquidity and commercial banks' need to find assets is a strong driver of the carry trade, which looks set to win out unless material geo-political risk breaks through," ING Bank said in a note.