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How will central bank tightening affect emerging market bonds?

Rajeev de Mello explains that emerging markets are prepared for tighter monetary policy and highlights the Asian countries offering the most attractive yields.

16/08/2017

Rajeev De Mello

Rajeev De Mello

Head of Asian Fixed Income

Emerging markets are prepared for central bank tightening

Investors are worried; they’re hearing noises from the US Federal Reserve and the European Central Bank about reducing balance sheets and hiking rates. They are wondering whether that will have an impact on emerging markets and on Asian bonds.

In the past, they’ve been right to worry. Generally, when central banks start tightening, it does affect emerging markets.

However, this time round, we’ve already had that event happen back in 2013, so the markets have got over it already.

The central banks in the West and the Bank of Japan have been careful to talk about a very gradual normalisation of the exit from very low interest rates and a very gradual reduction of their balance sheets.

So, there are no surprises, there’s plenty of communication and we think emerging market investors are well set up. Those that are invested should remain confident that we will not see a big drop off in values - at most, a small correction.

Which Asian countries offer the best yields?

In this very low global environment for volatility, we have to look for yields. Within Asia, we identify countries which have higher yields and very stable macroeconomic fundamentals.

Indonesia is one of the countries which we favour: 7% yields for 10-year bonds; a very stable currency; low deficits including a low trade deficit. These are generally all positives for bond investors.

India is another country we like: 6.5% yields around the 10-year part of the curve; also, low central government deficit; a lot of foreign inflows; stable currency.

China’s bonds also offer potential for investors: 3.5% yields but also the opportunity to have an offset in case there is some risk coming from China. Government bonds are usually the safe haven that investors flock to.