Man Group Says U.S. Yields Put Emerging Bonds at Tipping Point
(Bloomberg) -- Emerging-market bonds are becoming increasingly vulnerable as Treasury yields climb with the level of 2% on the U.S. 10-year note likely to trigger major outflows, according to Man Group Plc, which oversees $124 billion.
Developing-nation debt is also under threat due to stretched valuations, the prospect of quicker inflation and the danger of Federal Reserve missteps as it tries to counter the pandemic’s impact without overheating the economy, Lisa Chua, portfolio manager on the emerging-markets debt team at the group’s hedge-fund unit Man GLG in New York, said in an interview.
“The velocity of the moves in U.S. Treasury yields are now intensifying at a time when both hard currency and local emerging-market bonds are more vulnerable to such a move,” Chua said. “Valuations have gotten increasing stretched and positioning more crowded. In our view, emerging-market bonds have limited cushion left to absorb further increases in U.S. 10-year yields beyond current levels of around 1.5%.”
Emerging-nation bonds had a bumper end to 2020, rallying through the last nine months of the year amid the prospect of a global recovery from the coronavirus pandemic. The Bloomberg Barclays EM Local Currency Government Index gained 14% during the last nine months of 2020, reaching a record high in early January. They have since fallen 2.7% as concern central banks are getting close to withdrawing stimulus led to a selloff in bonds around the world.
In warning about the deteriorating outlook facing the sector, Man joins the likes of BlackRock Inc. and Fidelity International who have also recently sounded the alarm. BlackRock said there is no immediate end in sight for the taper scare, while Fidelity said the groundswell of reflation means the worst pain may still lie ahead for emerging-market bonds.
For Chua at Man GLG, a key tipping point may be approaching.
“If 10-year Treasury yields were to continue to climb toward 2% - a level we were at just a little over a year ago before the pandemic – this could trigger major outflows across hard currency and local emerging-market bonds.”
The main danger at present is not just the rising level of U.S. yields but the combination of a market that is overly complacent about the prospect of central-bank support, combined with the danger of Fed mistakes in combating the impact of the pandemic, Chua said.
The flood of capital into developing-nation assets is already starting to slow. Inflows into stocks and bonds fell to $31.2 billion in February from November’s record $107.4 billion, according to data from the Institute of International Finance.
“Euphoria over a seemingly supportive U.S. Fed, Biden fiscal stimulus and vaccine rollouts propelled many market participants further into the carry trade,” Chua said. In doing so, they turned a “blind eye to the reality that the additional carry versus Treasuries to take on that extra risk was quickly shrinking.”
Here are some of Chua’s other comments:
- “The inflation threat poses a real risk for investors. Just due to the base effect, both CPI and core PCE are likely to increase beyond 2% by the 2Q21. On top of the $900 billion fiscal package approved in December 2020, the Biden administration is likely to pass another $1.5 trillion or more of fiscal stimulus this year”
- “When considering all these factors together, this could put further pressure on inflation expectations and result in more persistent price increases”
- “While there has been progress in vaccine rollouts, even developed markets have faced delays and challenges associated with the distribution”
- “While it will vary from country to country, broadly speaking, emerging markets are likely to face more logistical challenges with regard to access and infrastructure, leaving risks for a hiccup with regard to vaccine distributions”
Asia Versus Other Regions
- “We are of the view that emerging-market debt is likely to face a broad-based correction irrespective of the region. The CNY for example, which exhibits a lower beta than global peers simply because the currency does not float as freely, is now at real-effective exchange rate valuations (adjusting for inflation differentials) that look extremely expensive”
- “On the high-yield side, rising rates would also bode negatively for debt sustainability concerns as the cost of funding grows”
- “In spite of wider spreads for high-yield emerging market bonds, outflows in the asset class could trigger sharp corrections at the bottom quality of spectrum””
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