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.
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.
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.
That’s not to say caution isn’t warranted. The Citi EM Inflation Surprise Index is at the highest since 2008, a reminder of how many investors were caught off guard by the resurgence of inflation.
“Risks are likely skewed toward faster tightening, rather than slower,” said Duncan Tan, a strategist at DBS Bank Ltd. in Singapore.
Inflation data from South Korea to Turkey and Poland this week may offer clues on the path for monetary policy. In Mexico, traders will monitor the central bank’s quarterly inflation report on Wednesday for signs that the monetary authority could adopt a less dovish outlook.
“Unless near-term data releases provide a confirmation to what is being priced, the current market pricing is vulnerable to a correction,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore.
“The market is already pricing in more hikes than what fundamentals are suggesting,” she said.
- The Reserve Bank of India is likely to hold its benchmark interest rate at 4% to help support the economy after a surge of coronavirus infections weighed on growth
- Investors will be looking for comments on debt purchases, which were set at 1 trillion rupees ($13.8 billion) this quarter. Bloomberg Economics expects bond purchases to be about 1 trillion rupees to 1.5 trillion rupees for the third quarter of the current fiscal year, and the introduction of more liquidity measures to support small and medium-sized businesses
- India’s government is scheduled to release quarterly economic growth data on Monday, which are expected to show a recovery was underway before the latest wave of virus infections. The rupee has strengthened 2.3% this month, Asia’s best performer
- Israel’s central bank may keep its base rate at a record low 0.1% on Monday as it gives the reopened economy more room to recover
- The shekel has been steady this month
- In Ghana, policy makers will probably keep the benchmark rate at 14.5%, the lowest since 2012, as a slow rollout of vaccines leaves the economy vulnerable to a third wave of infections, according to Bloomberg Economics
- Industrial-production numbers from South Korea and Taiwan this week should provide further clues on the pace of recovery across the region as investors assess whether market valuations are stretched
China will report manufacturing PMI for May on Monday, with economists expecting further expansion
- The yuan surged past key levels that have held for the past three years last week
- Inflation data for May is due from Indonesia and South Korea on Wednesday, while Thailand and the Philippines report theirs on Friday
South Korea is predicted to say export numbers jumped again in May in its monthly trade figures due Tuesday
- Underlying strength in external demand likely remained robust even after stripping out base effects, according to Bloomberg Economics. Exports were probably up about 13% compared with May 2019, it said
- Turkey’s CPI data will be closely watched on Thursday after the lira slumped to a record low on Friday amid concern that monetary policy remains too loose to curb accelerating inflation
- Consumer prices probably rose 17.3% in May following a recent hike in fuel tax, from 17.1% the previous month
- Turkey will also unveil data on Monday which will probably show the economy grew at a faster pace in the first quarter from a year earlier
- A reading of first-quarter Brazilian gross domestic product figures on Tuesday will be closely watched by investors weighing the scope of recovery against risks associated with the nation’s financing needs and ballooning debt load
- Industrial production data, to be released on Wednesday, is expected to provide the first aggregate reading for second-quarter growth, according to Bloomberg Economics. The real was the best-performer in Latin America in May
Chilean data on unemployment, retail sales and copper production for April will all be released on Monday, giving investors a better sense of how the nation is coping with the pandemic
- A gauge of the country’s economic activity in April, scheduled for Tuesday, will probably rise from a year earlier as growth benefited from expansionary fiscal and monetary policies, according to Bloomberg Economics
- Peruvian inflation through May is expected to be relatively stable, according to Bloomberg Economics. Investors will watch the nation’s assets as a high-stakes presidential election gets closer
Default and Restructuring
- Belize’s bondholders have until Tuesday to give their consent to extend the grace period on an interest payment due last week until September. The nation’s dollar bonds have the worst return on average this year among emerging-market sovereign notes tracked in a Bloomberg Barclays index
- Suriname will present elements and principles of its debt restructuring plans on Wednesday
— With assistance by Colleen Goko, Aine Quinn, Sydney Maki, Nicholas Reynolds, and Debarati Roy