Two schools of thought are developing in regard to emerging markets. One involves the risk of an asset price bubble; the other addresses the possibility that emerging markets could suffer the fallout of deteriorating sovereign credit worthiness in developed countries. Both ideas beg the question "could deteriorating sovereign risk in the developed world provide the needle that pricks a burgeoning emerging market bubble?"

To answer this question, let's first look at the risk of an asset bubble arising. There's no doubt that asset price gains in emerging markets have been particularly strong over recent months. However Citi analysts remain unconvinced that emerging markets are bubbling over.

Despite the sharp rise in emerging market equity prices, there are few of the signs that we've seen in past equity bubbles. The rise in emerging market indices to date is just a fraction of that seen during previous bubbles; valuations are below levels seen in a typical bubble, and emerging markets are de-equitising whereas bubbles tend to encourage significant equitisation.

With this in mind, we'll take a look at the growing concerns surrounding the credit worthiness of sovereign debt (debt issued by countries).

Sovereign rating trends show that over the last two years ratings downgrades have mainly involved emerging markets. Despite this, recent market concerns have been focused on the sovereign debt of developed countries, which historically have been regarded as "risk free".

Citi analysts note that at this point, the deterioration in sovereign credit worthiness of developed countries has really only applied to nations like Greece and Dubai, which could be regarded as peripheral to the developed world. The only real worry will come if sovereign risk becomes more visible in core developed countries like the US, UK, Japan and Germany, which make up the world's definition of "risk-free".

As a result, Citi analysts believe rising sovereign risk in developed countries poses little threat to emerging markets. However that's not to say emerging markets asset prices lack vulnerability.

For the foreseeable future, it may be monetary policy in developed nations rather than fiscal policy that poses the biggest near-term threat to emerging markets. Developing markets have suffered in the past when US monetary policy has been tightened - notably in 1994 when monetary tightening and a sharp sell-off helped to set the stage for Mexico's "tequila crisis". It should be noted that the tightening in US monetary conditions that year was extreme: Fed Funds rose by 250 bps to 5.5%, and the US 10-year yield rose by some 180 bps during the same period.

Citi analysts are not forecasting such a move in the near future, and the effects of any US monetary tightening may not be catastrophic, particularly if it is occurring against a background of strong recovery. Moreover, historical data indicates that capital flows to emerging markets have only been seriously threatened when US real interest rates turn substantially positive. As real short-term US interest rates are expected to stay negative or very close to zero, the risks here may be contained for the time being.