Higher U.S. Rates Now Threaten Post-Crisis Refuge for Yield

(Bloomberg) -- Add emerging-market local bonds to the growing list of securities losing some of their shine on the heels of higher U.S. rates.

After its relative resilience in February’s rout, the asset class -- which has offered shelter in the post-crisis world of low developed-market returns -- has a much-diminished buffer to weather external risks. A fresh outbreak of trade tensions, equity volatility or Treasury selling would leave emerging-market investors acutely vulnerable, according to Morgan Stanley.

Real yields tell the story. When adjusting for inflation expectations, emerging-market government bonds in local currencies now offer a more-modest pick-up to their U.S. counterpart, known as Treasury Inflation-Protected Securities, according to the bank. At 185 basis points, the spread between them is about 30 basis points below the post-crisis average, and over 70 basis points less than the premium offered in early 2017.

“Emerging-market bonds have outperformed over the last few months to the extent that relative valuations no longer look attractive in real terms,” said James Lord, a London-based strategist at Morgan Stanley, who’s now neutral on the asset class. “The erosion of this valuation cushion means emerging markets will be more dependent on the path of U.S. yields than before -- and creates a more uncertain backdrop for investors.”

To contact the reporter on this story: Sid Verma in London at sverma100@bloomberg.net.

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Cecile Gutscher

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