Snapshot

What do rising Treasury yields mean for local emerging market bonds?


  • Investors should expect rising US Treasury yields to result in higher emerging market (EM) local debt yields. However, history shows widely varying results when Treasuries move sharply. From here, and absent a change in US Federal Reserve (Fed) policy, we believe local rates are more likely to rise, but not as dramatically as Treasuries.
  • A fairly large yield cushion for EM local yields, of about 350 basis points on average, should help mitigate any sell off.
  • But results will be divergent. Low yielding EM with higher credit ratings like much of Asia and central Europe would fare worse, while higher yielders and most of Latin America would do better; from a rates perspective alone.

The steepening of the US Treasury yield curve this year, in particular the marked moves this past week, is drawing further comparisons to the Taper Tantrum of 2013.

To some extent, investor behaviour contrasts well with the Mayan conception of the universe, as others have noted previously. There is frequently a focus on the last crisis, but things are rarely the same.  

In Mayan mythology, the universe was destroyed on four occasions. The Mayans always learned a lesson, and planned to be prepared for the next disaster. Yet they were always looking backwards at the last event, rather than at the dangers ahead.

We maintain our view that EM are less vulnerable to a 2013 type scenario. But rising Treasury rates will nonetheless have implications for EM local debt.

How do local EM yields react to rising US Treasury yields?

In the past decade, there have been five periods when 30 year US Treasury yields rose 100 basis points, or nearly so, over an extended period. In the four previous episodes prior to the current one, local EM yields travelled in the same direction, but in varying degree.

The table below shows each episode. Importantly, EM yields tended not to sell-off to the same degree except when a shift in US policy was unfolding, such as the 2013 Taper Tantrum.

600609_Table2.jpg

In the current environment, EM local yields have actually fallen as US rates rose. We believe that with a lag, much of this will unwind but that it is unlikely to do so dramatically. EM central banks are not in or near extended hiking cycles, inflation is not rising materially more rapidly than in developed markets, and inflation (and rates) volatility has been structurally declining.

However, it’s clear from history that if the Fed’s hiking cycle comes sooner than expected, EM local yields would unambiguously be negatively affected.