Emerging market central banks are leading the way in tightening. Investors are waiting for next year.


The Czech Central Bank in Prague, Czech Republic. Emerging market central banks are leading the way in tightening.

Milan Jaros/Bloomberg

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Looking for yield in a low-yield world? And Brazil? The central bank has raised interest rates by 2% to 7.75% this year, and 10-year local currency bonds are yielding more than 11% a year. Mexican rates have risen from 4% to 5% since May. Poland has gone from 0.1% to 1.5% over the past two months. etc

“This is the first time in 35 years that I’ve seen emerging market central banks leading the way on tightening,” said David Robbins, portfolio manager of emerging market debt at TCW.

He and other managers aren’t piling on the bonds yet, though. Maybe next year. the

iShares JP Morgan EM Local Currency Bond

the exchange-traded fund (ticker: LEMB) is down more than 7% since September 1, a steep drop for fixed-income securities.

All other things being equal, a growing gap between US and foreign interest rates should revive what is known as the carry trade: investors borrow in dollars (or euros) and redeploy in reals, pesos or zlotys . But other things are far from equal as the world struggles to emerge from Covid-19 without reigniting runaway inflation.

Emerging market rate hikes are barely keeping pace with price increases, and inflation there looks more rigid than in developed markets. Inflation in the United States and Mexico is currently around 6%. In a year, the markets project the United States at 2.5%, Mexico stuck at 4.5%, says Phoenix Kalen, head of emerging markets research at Societe Generale. This dampens expectations of return.

Investors are instead emphasizing the negative for emerging markets. The Federal Reserve hints at a tightening to come to strengthen the dollar and evoke memories of the “tantrum” that sent emerging markets crashing in 2013. “This whole year has been a tantrum in fits and starts” , says Kalen.

The most aggressively advancing countries are also long on political risk. Brazil faces an election next year between two bad alternatives, from a market perspective: incumbent President Jair Bolsonaro and leftist ex-President Luiz Inacio Lula da Silva.

The peso slid to an eight-month low this week following Mexican President Andres Manuel Lopez Obrador’s out-of-left-field pick for central bank governor.

And Russia was a magnet for capital for much of the year due to the policy of rising rates and energy prices. Now it is collapsing as Vladimir Putin is massing armies against Ukraine. The ruble has lost 8% against the dollar over the past month, burning bondholders.

Asia offers fewer immediate risks and fewer rewards. Regional giants India, Indonesia and the Philippines are all keeping interest rates near record highs.

Next year could be better, investors say, with lower inflation and a spike in emerging market interest rates, just as the Fed begins to raise real interest rates. Rising rates are the enemy of bondholders. “Once we peak inflation, carry could come back strong,” says Luc D’hooge, head of emerging market bonds at Vontobel’s Fixed Income Boutique.

D’hooge expects that happy moment to happen in the spring of 2022, an educated guess at best. Another prerequisite: the continued slowdown in US economic growth – the third quarter rate was 2.1% year on year – while emerging markets accelerate the exit from the pandemic. “People like to see the growth differential with the developed world increase, not decrease, as it has,” says D’hooge.

Lots of ifs. “It could get darker before dawn,” says SocGen’s Kalen. Or the night could last a while.


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