Bets on rate hikes in emerging markets like South Africa are getting too high
When it comes to betting on higher borrowing costs in developing countries, some investors may get a head start.
In markets from South Africa to Mexico and South Korea, traders are forecasting a faster pace of interest rate hikes than economists currently say is justified based on the inflation outlook.
“Almost all of them are tightening prices,” said Shamaila Khan, head of emerging market debt at AllianceBernstein in New York, whose $ 4.7 billion high yield bond fund has passed 86%. of its peers last year.
The positioning reflects a common motive in the markets: After months of Covid-19 lockdown, there is a risk that policymakers will put their economy on a hot seat, only to backtrack with sharper-than-expected rate hikes across the board. line.
But the debate carries additional weight in emerging markets, an asset class that is particularly sensitive to the Federal Reserve’s position. This suggests how transactions could proceed quickly on any sign of policy remaining loose, potentially rewarding investors willing to look beyond the bearish outlook.
In Mexico, for example, market prices for swaps suggest an upward cycle could start as early as August, although the majority of economists say the central bank will refrain from tightening until at least February.
It’s a similar story in South Africa, where forward rate agreements provide for a 70% chance of a 50 basis point jump in six months, as Bloomberg’s monthly survey shows the rate will remain. unchanged until the end of the year.
Meanwhile, South Korea’s forward rate deals call for a rate hike of nearly 25 basis points over the next six months. In contrast, most economists do not foresee any change.
Against this backdrop, Khan of AllianceBernstein said his fund favored local debt in South Africa, Mexico and Russia, “where markets have over-integrated the path of key rates.”
U.S. central bank officials could start discussing the appropriate time to scale back their bond buying program at upcoming policy meetings, Fed Vice Chairman Richard Clarida said last week.
At the same time, the coronavirus continues to spread across large areas of the developing world, adding to the need for more stimulation.
In India, traders settled their bets on the rate hike last month as policymakers turned to a bond-buying program to prop up the economy against a new wave of infections. The Reserve Bank of India is expected to keep its benchmark interest rate unchanged on Friday and announce further debt purchases as the economy grapples with localized lockdowns implemented by most states.
JPMorgan Asset sees more gains for emerging bonds as dollar weakens
HSBC Holdings Plc says the prospect of central bank support being reduced later than current market prices suggest suggests that there is value in the beginning of the yield curve, including in Korea. South and Poland.
This is a view shared by Edwin Gutierrez, head of emerging market sovereign debt at Aberdeen Asset Management in London.
“We are long for South Africa and Mexico because we believe that the price curve in an upward rate path is not likely,” he said.
This is not to say that caution is not warranted. The Citi EM Inflation Surprise index is at its highest since 2008, a reminder of the number of investors caught off guard by the resurgence of inflation.
“The risks are likely tilted towards a faster tightening, rather than slower,” said Duncan Tan, strategist at DBS Bank Ltd in Singapore.
Inflation data from South Korea to Turkey and Poland this week could offer clues on the way forward for monetary policy. In Mexico, traders will be watching the central bank’s quarterly inflation report on Wednesday for signs that the monetary authority may take a less accommodative outlook.
“Unless short-term data releases provide confirmation of what is priced, current market prices are vulnerable to a correction,” said Eugenia Victorino, Asia Strategy Manager at Skandinaviska Enskilda Banken AB in Singapore. .
“The market is already forecasting more hikes than fundamentals suggest,” she said.
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