Taper-Tantrum Woes Fuel Hunt for Foolproof Emerging Markets

A worker wearing protective gloves counts U.S. dollar banknotes. (Photographer: Francesca Volpi/Bloomberg)

Taper-Tantrum Woes Fuel Hunt for Foolproof Emerging Markets

The debate about when the Federal Reserve will start scaling back bond purchases is driving some investors to emerging-market assets less exposed to a potential surge in U.S. yields.

William Blair Investment Management and Fidelity International are bulking up on high-yield or frontier bonds that are less sensitive to U.S. interest rates. Meantime, Bank of America Corp. is recommending that investors scoop up emerging-market euro-denominated bonds, predicting yields in the common currency will remain stable even when the Fed unveils plans to scale back its bond-buying campaign, probably in September.

Those moves are driven by memories of the 2013 “taper tantrum,” when developing-nation currencies and debt slumped for about six weeks as the dollar and U.S. rates rose in response to the Fed’s surprise suggestion that it would reduce debt purchases. Jobs data Friday showed robust growth, signaling the U.S. recovery is on track. The question remains as to when the Fed will deem the rebound strong enough to start withdrawing stimulus.

Taper-Tantrum Woes Fuel Hunt for Foolproof Emerging Markets

“A taper tantrum that leads to a spike in U.S. rates would start attracting investors out of most other asset classes, including emerging-market assets, into the U.S.,” said Randy Kroszner, an economics professor at the University of Chicago Both School of Business and a former member of the Fed’s Board of Governors. “That would be a time of flight to relative quality. That would be time when people move into relatively safer emerging-market assets and pull out of relatively riskier ones.”

Of course, a selloff may not be anywhere near the magnitude seen in 2013 because developing nations have better buffers today, including stronger current-account balances and positive real yields. Improving growth expectations will also support equities and some currencies. Still, investors remain concerned about a potential hawkish surprise from the Fed in the coming months that could reverse capital flows into emerging markets.

Taper Talk

“The emerging-market space will have to navigate around Fed communication on tapering,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. “Foreign positioning is also important. If there is a build-up in foreign positioning, the risk of a reversal in flows would have a more dramatic impact than if positioning had been light.”

Emerging-market bond funds attracted $3.4 billion of inflows in the four weeks through May 28, with equity funds drawing $6.6 billion, according to Bloomberg’s calculations based on EPFR Global data.

South Korea’s KEB Hana Bank is planning a series of investor calls starting Monday that may be followed by a dollar-denominated sustainability-bond offering. Oman and Saudi Aramco, the world’s biggest energy company, hired banks to manage their Islamic dollar bond offerings. Cameroon and Slovakia are also seeking to sell debt this month.

Local-currency debt is often seen as the most susceptible to any rise in the dollar or U.S. yields because either of those would reduce the carry return. A Bloomberg News study has identified that a 25-basis-point increase in yields in a month would be the tipping point for moves in higher-yielding currencies such as the Turkish lira, South African rand and Mexican peso.

Emily Weis, a macro strategist at State Street in Boston, recommends buying developing-nation equities. It’s a view shared by TS Lombard, which sees them as safer as they’re driven more by the dollar and U.S. stocks than Treasuries.

During the 2013 taper tantrum, the 120-day correlation between MSCI Inc.’s emerging-market equity index and Bloomberg Barclays’s Treasuries gauge was less than 0.2. At the peak of this year’s global bond selloff, the stock gauge barely showed a link to U.S. yields. That compares with correlations of about minus 0.6 with the Bloomberg Dollar Spot Index and 0.7 with the S&P 500.

Taper-Tantrum Woes Fuel Hunt for Foolproof Emerging Markets

Should the rise in U.S. yields be moderate, emerging-market high-yield dollar debt may also prove popular. Junk debt has gained about 1% this year to outpace lower-yielding investment-grade securities as the 10-year Treasury rate climbed to around 1.6% from 0.9%. Frontier markets offer an even higher buffer against rising rates, with the bonds of the world’s least developed economies returning 3.9% this year.

That’s pushed Fidelity International toward local notes from Egypt, Ghana and Uganda as well as foreign-currency bonds from Argentina, Ecuador and Zambia, said Paul Greer, a money manager in London at the firm, which oversees about $700 billion. William Blair’s Marcelo Assalin sees U.S. yields climbing toward 2% by year-end, boosting the appeal of junk debt.

Still, for others, determining the best place to ride out the tapering storm means examining how nations have fared during the pandemic. To do this, Eurizon SLJ Capital is looking at countries where demand for commodities and capital goods is stronger, said Alan Wilson, the firm’s portfolio manager.

He expects a tug of war between markets and the Fed over when to raise rates and is positioning for the higher yields that could follow by holding the foreign-currency debt of Egypt, Ghana and Oman.

“Ongoing U.S. exceptionalism is highly likely to result in further market tests of the accommodative stance of the Federal Reserve,” Wilson said.

Rate Decisions

  • Russia’s central bank will probably raise its benchmark interest rate on Friday, with analysts’ median forecast pointing to a 25-basis-point hike to 5.25%
    • The monetary authority will consider raising its key rate by 25 or 50 basis points or possibly keeping it unchanged, top officials said Thursday
    • “Monday’s inflation report could be pivotal,” Bloomberg Economics said in a report. “An upward surprise in the headline number or signs of firmer underlying price pressure would make a half-point hike more likely”
    • The ruble posted its best month this year in May following milder-than-expected U.S. sanctions, bolstering expectations for a gradual tightening in the coming months
  • On Tuesday, Chile is expected to keep benchmark interest rates on hold at 0.5%, while Peru announces its rate decision on Thursday
    • Chile will also report copper export figures for May on Monday after three straight months of gains. Copper prices have risen this year, providing a fiscal boost for the nation

Latam Risks

  • Investors will closely monitor the outcome of Peru’s presidential election, which pits leftist Pedro Castillo against Keiko Fujimori, the daughter of former President Alberto Fujimori. Castillo’s popularity in the polls has roiled markets
    • The runoff is on a knife edge, increasing the chances of a disputed election and calls for a recount as the country appeared split into two opposing camps
  • In Mexico, Mexican President Andres Manuel Lopez Obrador’s ruling coalition lost its super-majority in the lower house on Sunday, according to a quick count of midterm results, dealing a heavy blow to its chances of passing constitutional reforms
    • Still, the Mexican peso extended its recent gains on speculation that congress might provide a stronger check to the president’s power
    • On Friday, the nation’s industrial production is expected to show a 37% jump from the previous year as the economy recovers from the deepest recession in almost a century
  • Traders will also be watching inflation figures in Chile, due Tuesday, and in Brazil and Mexico on Wednesday
    • The data will give further evidence on the trajectory of price pressures in Latin America as economies rebound and the value of commodities soars
    • Mexico’s consumer prices probably increased in April by double the central bank’s 3% target, and while slowing in May, they will likely remain above target

Other Data

  • China’s exports continued to surge in May, data Monday showed, fueled by strong strong global demand as more economies around the world opened up. Imports soared, boosted by rising commodity prices
    • On Wednesday, Chinese authorities are expected to announce that producer-price inflation rose in May to the highest since September 2008. Consumer-price growth likely saw a mild jump, according to analysts in a Bloomberg survey
    • Credit data from China, due anytime between June 9 to June 15, is expected to show that aggregate social financing expanded last month
  • South Korea’s final first-quarter GDP is due Wednesday and likely to show a 1.6% quarter-on-quarter expansion, according to the median estimate in a Bloomberg survey of economists

    • The release comes after Finance Minister Hong Nam-ki said the government could still consider an extra budget -- which would be the sixth since the crisis -- even as the central bank signals it will rein in stimulus at some point
  • India’s industrial production figures for April will be closely watched for the impact of several state-level lockdowns in the month. According to Bloomberg economists, output likely dropped 14% in April from the previous month but the year-on-year reading will be distorted by last year’s low base
    • The rupee was the worst performer in Asia last week
  • On Tuesday, Indonesia and Malaysia will report foreign reserves, Taiwan will announce consumer-price inflation and trade numbers; unemployment figures from the Philippines are due for release
  • South Africa’s first-quarter GDP reading is due Tuesday, with economists predicting a quarterly expansion but an annual contraction following a wave of infections and continued power supply shortages
    • The rand leads emerging-market gains this year

©2021 Bloomberg L.P.

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