Surging U.S. Yields Loom Over Emerging Markets Beholden to Fed

Rising U.S. Treasury yields are starting to concentrate minds in the world of emerging markets.

Developing-nation local-currency bonds had their worst week since September in the five days through Friday, while dollar debt slipped by the most since January as surging inflation expectations fueled a rout in Treasuries. The selloff in the world’s largest bond market also sent implied volatility for currencies and stocks to the biggest weekly increase this year. Even so, exchange-traded fund investors looked past the increase in U.S. yields last week and continued to pour money into emerging markets.

All eyes will be on Federal Reserve Chair Jerome Powell’s testimony to Congress this week. The central bank chief is set to echo remarks that policy makers are fully committed to supporting the economy. Investors will also look for any sign that he’s troubled by steeper long-term borrowing costs after the real rates on long bonds rose above zero for the first time since June.

“We will still need to see the Fed vastly expanding its QE purchases, as the market simply can’t absorb the net U.S. Treasury issuance later this year without much higher real yields, which would eventually be toxic for asset markets,” John Hardy, head of FX strategy at Saxo Bank in Hellerup, Denmark, wrote in a report. “Rising yields don’t even necessarily have to trigger any notable meltdown in risk sentiment as long as the market is comfortable that real interest rates will continue to decline.”

Listen to the EM Weekly Podcast: Powell to Speak Amid Climbing U.S. Yields

A Bloomberg study in January found all developing-world currencies typically sell off when yields jump at a rate greater than about 25 basis points per month. The 10-year Treasury yield has risen about 26 basis points this month as of 11:30 a.m. in New York on Monday.

Oil will also keep traders on their toes, with Saudi Arabia and Russia differing once again on their output strategy heading into an OPEC+ meeting. The Mexican peso, Colombian peso and Russian ruble were among the worst performers in emerging markets as Brent crude retreated on Friday.

“Our optimistic emerging-market currency outlook is not without risks of setbacks along the way,” said Ehsan Khoman, head of emerging-market research in Europe, the Middle East and Africa at MUFG Bank in Dubai. “We believe relative cyclical outperformance and attractive yields on offer continue to favor stronger EM currencies as Covid-19 ebbs.”

South Korea and Hungary

  • The Bank of Korea is forecast to stand pat by unanimous consensus on Thursday
    • The most interesting aspect of the meeting could be any signals on government debt purchases. Lawmakers are planning to draw up another supplementary budget in the coming weeks, with the potential for additional debt issuance likely to put upward pressure on yields
    • BOK would prefer to use ad-hoc debt purchases to counter any bond market volatility rather than shift to a full-fledged quantitative-easing program, according to Bloomberg Economics
    • Korean 10-year bond yields rose nine basis points last week, mirroring moves in U.S. yields
  • Hungary will probably keep its base rate at 0.6% on Tuesday, with the forint among the worst performers in emerging markets this month
    • Hungary’s central bank had gained a reputation for being one of Europe’s most dovish before the coronavirus pandemic. Now, it’s among the the most hawkish, pursuing caution to prevent volatility in financial markets and inflation

Policy Clues

  • In Brazil, swap rates traders will watch a mid-February reading of consumer price inflation on Wednesday, which probably accelerated on an annual basis, underscoring bets on a rate hike in March

    • Investors will also monitor the congressional debate surrounding the 2021 budget and prospects for another round of cash handouts
    • January current-account data on Wednesday and unemployment and primary budget balance figures on Friday could offer further signs of the pandemic’s impact
    • President Jair Bolsonaro said more changes are underway after naming a former general to replace the University of Chicago-educated economist running state-controlled Petroleo Brasileiro SA
  • Mexico’s mid-month inflation data, scheduled for Wednesday, will be scrutinized after January consumer prices topped expectations

    • Policy makers will release the minutes from their February meeting on Thursday, which investors will monitor for clues on the central bank’s next steps after a unanimous decision to cut rates by 25 basis points
  • Malaysian January CPI on Wednesday is expected to remain negative
    • The January trade balance is likely to remain in strong surplus in data to be released on Friday
    • Ringgit was stock-still last week -- buffeted between opposing forces of strong dollar and robust oil prices as a net exporter of energy

South African Budget

  • South Africa’s Finance Minister Tito Mboweni will present the 2021-2022 budget on Wednesday
    • Mboweni must convince investors he has a credible plan to support an economy that contracted the most in nine decades last year, while also curbing growth in government debt
    • The market also wants clarity on plans for debt-ridden state-owned companies such as Eskom Holdings SOC Ltd. Nedbank Group Ltd. is leading discussions to restructure the South African power utility’s debt load, according to people familiar with the talks
    • The rand had its worst weekly performance since early January in the five days through Friday

Data and Events

  • Sudan’s central bank said Sunday it was implementing a unified exchange rate system, part of broader measures aimed at reviving its struggling economy
  • South Korea’s early exports increased at the fastest pace in more than two years in February

    • The nation’s export numbers often contain early clues on global production. For instance, a Bloomberg study covering 2015-19, shows a 23% correlation between misses versus consensus for these figures and misses from the subsequently available U.S. ISM data
    • The won was flat last week, despite the rise in the U.S. dollar, perhaps insulated by past poor performance against its behavioral drivers
  • Thailand’s trade numbers are due on Tuesday. The balance should be just above zero, with a steep decline in imports responsible for keeping the numbers in the black
    • January’s current-account figures may show a third straight deficit in data to be released on Thursday
    • Thai baht depreciated 0.4% last week, a little more than the global average
  • Taiwan’s January export orders might show another sizable increase on Wednesday, with consensus about 46% year-over-year
    • January industrial production is likely to tell a similar story of rapid recovery on Thursday -- with consensus at about 19% year-over-year
    • Another vast current-account number for the fourth quarter will be released on Friday
    • Taiwan’s dollar was one of the top gainers in Asia last week
  • India’s fourth-quarter GDP due Friday is likely to show the first year-over-year expansion since the first three months of 2020
    • The Indian rupee was one of the strongest performers in Asia last week as inflows poured into local equity markets
  • China’s official February PMIs –- for both manufacturing and services are due on Feb. 28
    • The Chinese yuan was the third-weakest currency in Asia last week, although the stronger-than-expected fixing in yuan terms on Friday offered a glimmer of hope for bulls
    • Read more: Yuan Fixing Miss May Herald Future Dollar Decline
  • A reading of Peru’s fourth-quarter gross domestic product, scheduled on Monday, may show a recovery from the lows seen amid the emergence of Covid-19 while lingering below levels from before the pandemic, Bloomberg Economics estimates.
  • Chile’s January copper production on Friday will be watched as the metal trades near decade highs, fueling a rally in the peso
  • A gauge of Argentina’s economic activity index may flag a slowdown in December after seven straight monthly gains, according to Bloomberg Economics

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