Emerging bonds disrupt playbook by rallying as treasuries swoon
The old playbook of selling emerging-market bonds when treasury yields spike is being upended by the positive dynamics favoring developing-nation debt.
By Marcus Wong, Tassia Sipahutar and Matthew Burgess // Bloomberg
Emerging bonds denominated in local currencies have extended this year’s rally — even as treasuries slide — amid growing expectations for interest-rate cuts and optimism over a soft landing for the global economy. The correlation between emerging and US yields has dropped to almost zero, a Bloomberg study shows.
“The disinflation process in emerging markets is proceeding faster than we had previously expected — this should allow EM central banks to cut rates sooner and faster than developed-market ones,” says Arun Sai, senior multi-asset strategist at Pictet Asset Management in London. “We remain overweight EM local-currency bonds.”
While the Federal Reserve and many of its developed-nation peers have left the door open for further rate hikes, some of their emerging-market counterparts have already started to cut borrowing costs.
Chile’s central bank lowered its key rate by a greater-than-expected 100 basis points last month, a decision that sent two-year bond yields plunging on the next trading day. Brazil’s policy makers trimmed their benchmark by a larger-than-forecast 50 basis points on Aug. 2.
The consensus for rate cuts in Latin America suggest markets are not yet pricing in the full extent of likely easing.
Elsewhere, Hungary’s central bank trimmed its key rate for a third-straight time last month, while policy easing is also being debated in Poland and the Czech Republic.
Soft Landing
Growing optimism the Fed will be able to counter inflation without bringing about a recession is also favoring emerging-market bonds more than their developed peers.
“Higher bond yields in developed markets signal a lower probability of a global recession,” says Rajeev De Mello, global macro portfolio manager at Gama Asset Management SA in Geneva. “I expect more resilient global growth to be the dominant force for emerging-market assets.”
The above factors help explain why the link between emerging-market bonds and treasuries is breaking down. The 30-day correlation between US 10-year yields and a Bloomberg index of EM local-currency bonds has fallen to around 0.1, according to analysis by Bloomberg, where zero would indicate no correlation. When US yields surged in February, the correlation rose as high as 0.57, while in March to June 2022, it topped out at 0.61.
China Exports
The slowdown in China is also a positive for broader emerging-market bonds.
Recent data from the world’s second-largest economy has added to signs its recovery is faltering. Exports slid in July by the most in more than three years, while consumer and producer prices both dropped last month, the first time that’s happened since 2020.
The collapse in China’s export prices and the weak yuan means the country is essentially “exporting disinflation” to its trading partners in Asia, especially in Southeast Asia, and that is “on the margin, a positive for both bonds and equities” in the region, Pictet’s Sai says.
Dollar Strength
Among the biggest negatives facing emerging-market bonds is a resurgent dollar, which will reduce returns from local-currency assets.
Dollar strength driven by the hawkish Fed has pushed down the MSCI emerging-market currency index by 1.8% in August, on track for the biggest monthly loss since February. The Bloomberg Dollar Spot Index has gained about 1.5% this month.
Still, “the dollar looks overvalued across a suite of valuation metrics, and is less of a headwind to EM local-currency bonds, making it likely that compelling carry can resume its role as key driver of returns,” Grant Webster, a fund manager at Ninety One UK Ltd. in London, wrote in a client note published Tuesday.
Dip Buyers
Even if emerging-market bonds do decline, any losses may be seen as a buying opportunity given the many positives.
A better time to be buying EM debt is during generalized selloffs due to risk aversion related to something else, such as in March with the US regional banks, Samy Muaddi, head of emerging markets fixed income at T. Rowe Price, said in an interview in Melbourne.
”Getting green technology companies through the growth phase is like sailing a ship through a perfect storm,” says Laurits Bach Sørensen, Senior Partner at Nordic Alpha Partners.
Investors and asset managers remain positive about the benefits of artificial intelligence – despite some concerns about geopolitics and their possible effects on tech giant Nvidia.
So far, Ridge Capital’s Nordic high yield strategy has exceeded the targeted return, founders and portfolio managers Måns Levin and Christoffer Malmström tell AMWatch.
KLP and the KLP funds are excluding the American machinery manufacturer due to the risk of contributing to violations of human rights and international law in the West Bank and Gaza.
Kyrkans Pension broke FSA rules when the pension fund made a major investment in real estate company Stelvalvet, the Swedish Financial Supervisory Authority says.
Akademikerpension is divesting investments worth DKK 324m (EUR 43.4m) in 30 drilling companies. Until now, the pension fund had been unaware of the involvement of these companies in fossil expansion.
American Century’s Pia Michelsson tells AMWatch that impact investing in the Nordic region is ”next level” in this first article of our 2024 Summer Series featuring international asset managers.
The Head of Danske Bank Asset Management, Christian Heiberg, had expected more new mandates by now for its EMD strategy, which has shown world-class performance since a new team took over.
The owners of infrastructure fund manager AIP Management have sold the majority of their shares to Storebrand, one of Norway’s largest financial groups.
Northvolt, the Swedish manufacturer of sustainable batteries for electric vehicles, is facing a mountain of problems as the market for its products appears to be saturated.
So far, Ridge Capital’s Nordic high yield strategy has exceeded the targeted return, founders and portfolio managers Måns Levin and Christoffer Malmström tell AMWatch.
American Century’s Pia Michelsson tells AMWatch that impact investing in the Nordic region is ”next level” in this first article of our 2024 Summer Series featuring international asset managers.