Indian Summer Comes to Emerging Markets as Fed Spurs Fresh Gains

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(Bloomberg) -- The Federal Reserve has given fresh impetus to emerging markets.

As Russia joined Argentina in announcing a Eurobond sale, stocks from Istanbul to Johannesburg rallied at least 2 percent, South Africa’s rand extended its longest winning streak since 2013 and Standard Chartered Plc recommended buying the lira, this quarter’s worst-performing major currency outside of Latin America.

Pledges to keep monetary policy accommodative from the Fed and Bank of Japan this week have emboldened the hunt for higher-yielding assets by investors seeking to escape near-zero rates in much of the industrialized world. Exchange-traded stock and bond funds registered $20.5 billion of uninterrupted inflows in the past 16 weeks.

“The Fed’s dovish tone has created an Indian summer for the rally in emerging markets,” said Guillaume Tresca, a senior emerging-market strategist at Credit Agricole CIB in Paris, who recommends buying the rand in the short term. “High-yielders fashionable again. We expect inflows, but not as much as during the summer. Investors have become more discriminate.”

Following the Fed’s decision to keep U.S. interest rates on hold on Wednesday:

  • Russia said it would sell as much as $1.25 billion tapping the nation’s first Eurobond since sanctions were imposed
  • Argentina announced investor meetings for a benchmark-sized euro-denominated bond
  • Turkish bonds, the worst performers in emerging markets this quarter, rallied the most in eastern Europe and Africa, with 10-year yields falling the most since May
  • The rand appreciated 0.8 percent, bringing its seven-day advance to 6.8%, and Chile’s peso jumped 1.2 percent
  • Standard Chartered strengthened its year-end lira forecast to 2.90 per dollar from 3.10
  • Hungary’s forint jumped to the highest level since May 2015
  • MSCI emerging market stock and currency gauges reversed last week’s losses

The MSCI Emerging Markets Index of equities rallied 1.6 percent to 919.90 by 2:04 p.m. in London, bringing its four-day increase to 3.9 percent. The gauge dropped 2.6 percent last week. All 11 industry groups advanced on Thursday, led by consumer shares.

Stock Outperformance

Companies on the gauge trade at an average valuation of 12.7 times projected 12-month earnings, compared with a multiple of 16.2 for the MSCI World Index of advanced-nation shares. Appetite for riskier assets has helped the developing-world gauge outperform its peer in 2016, climbing 16 percent versus an increase of 4.3 percent for the MSCI World.

Currencies were also bolstered on Thursday, as the MSCI Emerging Markets Currency Index climbed 0.8 percent due to dollar weakness after the Fed Open Market Committee trimmed its forecasts for future rate increases. The premium investors demand to hold emerging-market bonds over U.S. Treasuries narrowed five basis points to 329, within five basis points of a 16-month low.

While investors have been bullish on developing countries all year, money flowed into funds that passively track emerging-market stock and bond indexes at the slowest pace in three months last week amid concern the Fed and the Bank of Japan would curb stimulus.

Bond Rush

The Fed’s so-called “dot plot,” which it uses to signal its outlook for borrowing costs, shows policy makers see only two moves next year, down from a June projection of three. The gradual pace of increases is poised to support the argument for investing in emerging markets.

Morgan Stanley and Goldman Sachs Group Inc. said in the past week that the countries have stronger economic fundamentals than they did during the so-called 2013 taper tantrum, putting them on a better footing to withstand a move away from ultra-loose monetary policy.

The yield on Russian dollar-denominated bonds due in May 2026 has fallen 92 basis points to 3.83 percent since the government’s initial offering, organized by a sole state-run lender, four months ago.

Emerging-market bonds are an asset class that is “here to stay” because Fed policy suggests there’s unlikely to be any aggressive dollar appreciation, Peter Kinsella, the head of emerging-market economic and foreign-exchange research at Commerzbank AG in London, said in an interview. “Yield pick-up in EM U.S.-dollar denominated issuance is going to stay for quite some time.”

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