When it comes to betting on higher borrowing costs in the developing world, some investors may be getting ahead of themselves.

In markets from South Africa to Mexico and South Korea, traders are penciling in a faster pace of interest-rate hikes than what economists say is currently warranted based on the inflation outlook.

“Almost all of them are overpricing tightening,” said Shamaila Khan, the head of emerging-market debt at AllianceBernstein in New York, whose $4.7 billion high-yield bond fund has topped 86% of peers in the past year.

Money markets are leaning toward South African rate tightening this year

The positioning reflects a common motif in markets: After months of Covid-19 lockdowns there’s a risk that policy makers run their economies hot, only to backtrack with sharper-than-expected rate hikes down the line.

But the debate carries extra weight in emerging markets, an asset class that’s particularly sensitive to the Federal Reserve’s stance. And it suggests how trades could quickly unwind on any signs of policy staying loose, potentially rewarding investors willing to look past the bearish outlook.

In Mexico, for instance, the swap-market pricing suggests a hiking cycle could start as soon as August, even though 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 are pricing in a 70% probability of a 50-basis-point jump in six months, whereas Bloomberg’s monthly survey shows the rate staying unchanged until year-end.

Meantime, South Korea’s forward-rate agreements are pricing in close to a 25 basis-point rate increase in the next six months. In contrast, most economists predict no change.

Against this backdrop, AllianceBernstein’s Khan said her fund favors the local debt of South Africa, Mexico and Russia, “where markets have priced in too much in terms of the policy rate path.”

U.S. central bank officials may be able to begin discussing the appropriate timing of scaling back their bond-buying program at upcoming policy meetings, Federal Reserve Vice Chair Richard Clarida said last week.

Inflation Overshoot

At the same time, the coronavirus continues to spread in large swathes of the developing world, underlying the need for more stimulus.

In India, traders unwound their rate-hike wagers last month as policy makers turned to a bond-buying program to support the economy against another wave of infections. The Reserve Bank of India is likely to keep its benchmark interest rate unchanged on Friday and announce further bond purchases as the economy struggles with localized lockdowns implemented by most states.

HSBC Holdings Plc says the prospect that central bank support gets scaled back later than what current market pricing implies suggest there’s value in the front-end of the rates curve, including in South Korea and Poland.

It’s a view echoed by Edwin Gutierrez, the head of emerging-market sovereign debt at Aberdeen Asset Management in London.

“We are long South Africa and Mexico as we do think that the curve prices in a rate hiking trajectory that is not likely,” he said.

Market Correction

Source Google News