What Emerging-Market Bulls Say About a 3% Treasury Yield

(Bloomberg) -- Who’s afraid of rising Treasury yields?

Not the emerging-market bulls.

As the yield on the benchmark 10-year Treasury note heads toward 3 percent for the first time since December 2013 on a closing basis, commentators from BNP Paribas Asset Management to Mitsubishi UFJ Kokusai Asset Management Co. say growth in developing economies is sturdy enough to withstand increased U.S. borrowing costs -- just as long as they don’t rise too fast.

Emerging-market assets are still holding their gains this year even after the two-week sell-off from end-January that was triggered by concerns about accelerating inflation and the fiscal deficit. Only emerging-market dollar debt has had losses this year, according to a Bloomberg Barclays index.

Here’s what investors and analysts say about the prospect of resurgent yields.

David Fernandez, chief Asia-Pacific economist, at Barclays Plc:

• Barclays expects the rise in U.S. 10-year Treasury yield to be limited at 2.9 percent; just because the Federal Reserve continues to hike rates, it’s not clear if the entire yield curve would continue to shift higher; the actual Fed tightening would bring down inflation expectations
• A cap on Treasuries around the 2.9 percent level would keep the markets constructive for risk assets, including for emerging markets
• In the alternate scenario where the yield moves quickly through 3 percent, then emerging markets are in for “a challenging time” because they’ve had a huge amount of inflows for an extended period of time; it’s always difficult for EM to deal with a Treasuries rout

Manik Narain, a strategist at UBS Group AG in London:

• If growth in Europe and China holds up and the dollar remains weak, “emerging markets can withstand the pressure of higher U.S. yields”; Turkish lira and Philippine peso could feel the heat, “given their external imbalances and low real rates”
• “There is also a perception that the pace at which U.S. rates moves matters as much as the level”
• “If the dollar strengthens in an isolated manner i.e. we get broad dollar strength, as long as that doesn’t cause a commodity collapse it’s very easy for emerging market investors to hedge against that (they just have a short EURUSD position)”
• “What’s trickier for markets is if U.S. growth/inflation accelerate while Europe/China cool. That means currencies likely depreciate in trade-weighted terms, which is hard to hedge against, and volatility likely picks up. So far China and especially Europe have been holding up well”

Takahide Irimura, Tokyo-based economist at Mitsubishi UFJ Kokusai Asset:

• It may encourage some fund outflows from emerging markets as U.S. Treasury yields continue to rise, but it’s unlikely to see significant outflows like 2013. Investors have put money into emerging markets knowing that the Fed has begun to raise rates 
• Fundamentals in emerging markets are now much better than in 2013 when five major EM currencies -- India, Indonesia, South Africa, Brazil and Turkey -- weakened significantly. Current accounts of most of those countries have improved since then, and inflation has stabilized, making them more resilient to external shocks
• So, even if the benchmark Treasury yield reaches 3 percent, I don’t expect sharp, panic-type fund outflows from emerging markets. When the rate moves toward the 3.5 percent to 4 percent area, some investors may sell, based on the narrowing interest-rate differentials, but still, panic selling of EM assets is unlikely

Karan Talwar, Hong Kong-based investment specialist for emerging-market debt at BNP Paribas Asset Management

• Still positive on the outlook for emerging debt markets as growth momentum in emerging markets continues to improve
• “We have a view that 10-year U.S. Treasuries will be range trading between 2.5 and 3 percent. As long as the move is gradual we do not see this as a major disruption for emerging-market assets”
• Still likes EM currencies, but is now “more cautious” 
• Recent widening of EM dollar-debt spreads in the second week of February has given opportunity for company to add some exposure in select frontier markets

Anthony Raza, head of multi-asset strategy, at UOB Asset Management Ltd.

• Economic data are “pretty clear” that there’s good global growth and earnings are being upgraded across the world, including emerging markets. In a good global growth environment, emerging markets do well
• Raza says that’s what the 10-year U.S. Treasury yield is reacting to; yields are saying growth is better than we’ve seen in the last five years and is starting to “normalize,” which shouldn’t be a problem for emerging markets
• Generally, good global growth points to stronger exports, which would favor the equities in North Asian economies of South Korea and Taiwan

To contact the reporters on this story: Lilian Karunungan in Singapore at lkarunungan@bloomberg.net, Yumi Teso in Bangkok at yteso1@bloomberg.net, Constantine Courcoulas in Istanbul at ccourcoulas1@bloomberg.net.

To contact the editors responsible for this story: Tomoko Yamazaki at tyamazaki@bloomberg.net, Justin Carrigan at jcarrigan@bloomberg.net, Alex Nicholson

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