Dollar doldrums drive traders to emerging market local bonds
Mexico/ Lima/ New York: Bets that the US dollar will drop even further this year are boosting the appeal of local currency emerging market bonds.
Demand for the notes is poised to grow thanks to the combination of bearish wagers on the dollar—which has posted its worst start to a year since 2006—and higher interest rates in developing nations.
The yield differential has triggered record inflows to emerging-market funds in the first half of 2017, with most going to notes issued in foreign currency, said Morgan Stanley analysts.
The tide may shift as returns for local-currency securities are more than four percentage points higher, according to the bank.
The chances of a pullback are clearly higher for hard-currency debt, Morgan Stanley analysts led by Simon Waever said in a June 30 note.
“In local currency, technicals look more positive, as cumulative flows into local debt have only recovered around half of the outflows seen since 2013.”
The recent emerging-market bond selloff is mostly due to some central banks in developed economies signalling monetary policy tightening.
Still, real rates in emerging markets are expected to remain high enough to justify the risk for many investors, especially with inflation slowing in many of these economies.
HSBC Holdings Plc is bullish on local currency government bonds in Mexico, South Africa, India, Indonesia, Malaysia and Russia, citing an expected drop in inflation risk premiums that will likely trigger flatter yield curves, or the difference between short- and long-term debt yields.
The risk premium on sovereign emerging-market dollar bonds dropped one basis point to 312 basis points on Tuesday, according to JPMorgan indexes.
With real interest rates averaging zero percent in developed nations and 3 percent in emerging markets, investor appetite should remain high for both local and hard-currency notes, said Carl Ross, an analyst at Grantham Mayo Van Otterloo & Co., which oversees $7.1 billion in emerging-market bonds.
Still, he favours local-currency debt on bets that further gains can be made if the US dollar falls in the second half of the year.
“They may not be as attractive now, but they still look decently attractive versus the dollar,” he said.
The efforts some emerging-market governments have taken to shore up their economies are also encouraging investors. Improving current accounts and healthier fiscal balances have driven “positive momentum for economies such as Brazil, Russia and Colombia,” said Pierre-Yves Bareau, who oversees $39 billion as the head of emerging-market debt at JPMorgan Chase & Co.’s asset-management unit. Bloomberg
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