Snapshot

Are local EM bonds approaching a turning point?


Emerging market (EM) central banks have been hiking interest rates in response to rising inflation. This is not great news for bonds, and with inflation remaining sticky, further hikes are likely needed.

As growth momentum starts to ease off, however, this will allow for more moderate policy tightening. Added to this, the average yield of local currency EM debt has risen nearly 100 basis points (bps) so far this year.

Local-EM-yields-higher.png

We think EM bond markets are close to an inflection point, where the likelihood of diminished rate hikes meet attractive yields. At the same time, individual country risks vary and remain key.

Russia leads the way

Russia recently surprised markets with a lower than expected interest rate hike of 25bps, to 6.75%, against expectations of 50bps. While the rhetoric accompanying the move was hawkish, it represented a rare case where the market showed no sign of discomfort with a less aggressive EM central bank policy trajectory.

Russia's early response to inflation, the central bank has tightened its key policy rate by 250bps since February, and a deep well of credibility, worked to its advantage. Though inflation remains well above the 4% target, at around 7%, it is clear the market believes the foreseeable trajectory will bend favourably. With the 10-year yield approaching 7%, this is starting to present decent value.

Focus on country specific factors

Mexico may join Russia as the next country to begin hiking rates less aggressively, having surprised the market with a 25bps hike in June, followed by another 25bps in August. The market expectation for 100bps of additional hikes is probably too high.

Hiking cycles in Peru and Chile will likely exceed that, however, and Colombia’s central bank seems particularly behind the curve as well. Brazil has been aggressive with hikes, but higher inflation recently suggests the central bank should probably have been even more so, given the low starting point of 2% nominal rates. These countries would benefit the most from exogenous factors, such as easing food and inflation pressure, that become tailwinds.

In Asia, where slower economic growth is already occurring, rates will stay low but stable and still attractive relative to developed markets.

EM-real-rates.png

 

The views and opinions contained herein are those of the Authors, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

 

This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

 

Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested.

 

Schroders has expressed its own views in this document and these may change (to be used if the 1st statement above is not being used).

 

Schroders will be a data controller in respect of your personal data. For information on how Schroders might process your personal data, please view our Privacy Policy available at www.schroders.com/en/privacy-policy or on request should you not have access to this webpage.

 

Issued by Schroder Investment Management (Europe) S.A., 5, rue Höhenhof, L-1736 Senningerberg, Luxembourg. Registered No. B 37.799. For your security, communications may be taped or monitored

 

The forecasts stated in the document are the result of statistical modelling, based on a number of assumptions. Forecasts are subject to a high level of uncertainty regarding future economic and market factors that may affect actual future performance. The forecasts are provided to you for information purposes as at today’s date. Our assumptions may change materially with changes in underlying assumptions that may occur, among other things, as economic and market conditions change. We assume no obligation to provide you with updates or changes to this data as assumptions, economic and market conditions, models or other matters change.