(Bloomberg) – The debate over when the US Federal Reserve will start cutting bond purchases is pushing some investors to emerging market assets that are less exposed to a potential surge in US yields.
William Blair Investment Management and Fidelity International are increasingly investing in high-yield or frontier bonds, which are less sensitive to US interest rates. In the meantime, Bank of America Corp. recommends encourages investors to scoop euro-denominated emerging market bonds and predicts that single currency yields will remain stable even if the Fed announces plans to reduce its bond buying campaign in September.
These moves are fueled by memories of the 2013 “taper tantrum” when developing country currencies and debt collapsed for about six weeks as the dollar and US interest rates fell in response to the Fed’s surprise proposal to cut bond purchases , rose. Friday’s labor market data showed robust growth and signals that the US recovery is on the right track. The question remains when the Fed thinks the recovery is strong enough to begin unwinding.
“A taper tantrum, causing US rates to rise, would attract investors from most other asset classes, including emerging market investments,” said Randy Kroszner, economics professor at the University of Chicago’s Both School of Business and a former member of the Fed’s Board of Governors. “That would be a time to escape to relative quality. That would be when people move to relatively safer emerging market investments and pull out of relatively riskier ones. “
Of course, a sell-off cannot come close to 2013 levels as developing countries have better buffers today, including stronger current account balances and positive real returns. Improving growth expectations will also support stocks and some currencies. Still, investors remain concerned about a potential restrictive surprise from the Fed in the coming months that could reverse the flow of capital to emerging markets.
“The emerging markets have to take care of Fed communications when tapering,” said Eugenia Victorino, Head of Asia Strategy at Skandinaviska Enskilda Banken AB in Singapore. “Positioning abroad is also important. If foreign positioning accumulates, the risk of a reversal of currents would have a more dramatic impact than a slight positioning. “
Emerging market bond funds saw $ 3.4 billion in inflows in the four weeks ended May 28, while equity funds raised $ 6.6 billion, according to Bloomberg’s calculations based on EPFR Global data.
South Korean KEB Hana Bank is planning a series of bond issues starting Monday, which may be followed by a dollar-denominated offering of sustainability bonds. Cameroon and Slovakia are also trying to sell debt this month.
Local currency bonds are often viewed as the most vulnerable to a surge in US dollar or US yields, as either would reduce the carry yield. A study by Bloomberg News found that an increase in yields of 25 basis points in one month would be the tipping point for moves in higher-yielding currencies like the Turkish lira, South African rand and Mexican peso.
Emily Weis, a macro strategist on State Street in Boston, recommends buying developing country stocks. That view is shared by TS Lombard, who sees them as safer since they are driven more by the dollar and US stocks than government bonds.
During the Taper Tantrum in 2013, the 120-day correlation between MSCI Inc.’s emerging market stock index and Bloomberg Barclays’ Treasuries reading was less than 0.2. At the height of this year’s global bond sales, the stock display showed little connection to US yields. This contrasts with correlations of around minus 0.6 with the Bloomberg Dollar Spot Index and 0.7 with the S&P 500.
Should the rise in US yields be moderate, high-yield dollar bonds from emerging markets could also prove popular. Junk debt rose 1% this year to outperform lower-yielding investment-grade securities as the interest rate on 10-year government bonds rose from 0.9% to around 1.6%. Frontier markets provide an even bigger buffer against rising interest rates, with bonds from the world’s least developed economies returning 3.7% this year.
That has pushed Fidelity International to local banknotes from Egypt, Ghana and Uganda as well as foreign currency bonds from Argentina, Ecuador and Zambia, said Paul Greer, an asset manager in London with the firm, which manages about $ 700 billion. William Blair’s Marcelo Assalin expects US yields to climb to 2% by the end of the year, which will make junk debt more attractive.
Still, for others, determining the best place to weather the rejuvenating storm means examining how nations fared during the pandemic. To this end, Eurizon SLJ Capital is studying countries where demand for raw materials and capital goods is stronger, said Alan Wilson, the company’s portfolio manager.
He anticipates a tug-of-war between markets and the Fed on when to raise rates and positions himself for the higher returns that could follow by holding the foreign currency debt of Egypt, Ghana and Oman.
“Persistent US exceptionalism will most likely lead to further market testing of the Federal Reserve’s accommodating stance,” said Wilson.
Russia’s central bank is likely to hike its key rate on Friday, with analysts’ median forecast pointing to a 25 basis point hike to 5.25%. The monetary authority will consider raising its policy rate by 25 or 50 basis points, or possibly leaving it unchanged, top officials said Thursday. “Monday’s inflation report could be crucial,” Bloomberg Economics said in a report. “An upside surprise in the headlines or signs of stronger underlying price pressure would make a half a point more likely.” The ruble had its best month of the year in May after milder-than-expected US sanctions, bolstering expectations of a gradual tightening in May In the coming months On Tuesday, Chile is expected to leave its key interest rate at 0.5%, while Peru will announce its interest rate decision on Thursday. After three profit months in a row, Chile will also report copper export figures for May on Monday. Copper prices have soared this year, giving the nation a fiscal boost
Investors will be closely monitoring the outcome of the Peruvian presidential election, in which left-wing Pedro Castillo will face Keiko Fujimori, daughter of former President Alberto Fujimori. Castillo’s popularity in the polls has shaken the markets in Mexico, President Andres Manuel Lopez Obrador’s ruling Morena party is facing a test for the populist leader’s agenda in the midterm elections. Lopez Obrador and his party are vying to keep their super majority in the lower house with 500 seats in the country’s largest election to date by number of candidates. Even so, the Mexican peso is up 7.7% from its recent low in March, while the economy is moving from its deepest recession in nearly a century. On Friday, Mexico’s industrial production is set to rise 37% year-over-year, and inflation figures in Chile on Tuesday and in Brazil and Mexico on Wednesday keep an eye on price pressures in Latin America as the economy recovers and the value of commodities rises Consumer prices in Mexico were likely to double the central bank’s target of 3% in April and while they did slow down in May, they will likely stay above target
China’s trade balance, due on Monday, likely remained strong in May, with both import and export growth picking up, according to Bloomberg Economics. Authorities are expected to announce on Wednesday that producer price inflation rose to its highest level since September 2008 in May. According to analysts in a Bloomberg poll, price growth has likely increased slightly. Credit data from China due between June 9 and June 15 is expected to show that aggregate social finance expanded last month
South Korea’s final GDP for the first quarter is expected on Wednesday and, according to the median estimate in a Bloomberg poll of economists, should show growth of 1.6% compared to the previous quarter
The release comes after Finance Minister Hong Nam-ki said the government could still consider an additional budget – which would be the sixth since the crisis – even if the central bank signals that it will at some point curb India’s industrial production numbers for April Monitored closely for the impact of multiple state-level bans during the month. According to Bloomberg economists, April production was likely down 14% from the previous month, but the previous year’s figure is skewed by last year’s low base.The rupee was the worst performing in Asia last week, on Tuesday Indonesia and Malaysia will report foreign reserves, Taiwan will Announce consumer price inflation and trade figures; Unemployment figures from the Philippines to be released South Africa’s first quarter GDP readings are expected on Tuesday, with economists predicting quarterly expansion but annual contraction following a wave of infections and persistent electricity shortages The Rand will lead to profits in emerging markets this year
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