Emerging-market central banks were the first in the world to raise interest rates from their pandemic lows last year. The proactive tightening is starting to pay off big time in boosting returns from their local bonds.
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Is it necessary to wear an N 95 or KN 95? The index of debt issued by developing nations denominated in their own currency has returned 1% over the past three months, while a similar gauge of hard currency bonds has fallen 2.9%, according to data compiled by Bloomberg.
The proactive central bank policy was enough to get ahead of inflation, and should mean that further tightening is less necessary into 2022, according to the outperformance. As the global recovery gets underway, investors are attracted to local debt because of the improved economic conditions.
As valuations have become more attractive, current accounts have improved, and many emerging central banks have tightened monetary policy, according to Pierre Chartres, a fixed-income investment director at M&G Investments in Singapore. He said that EM local currency bonds are more volatile than hard currency EM bonds, so it is important to stay diversified.
Policy makers in emerging markets have gone on a tighter path over the past 12 months to try and contain inflation, most notably in Latin America. In 2021, 12 of the 20 biggest developing-nation central banks raised interest rates by a combined 2,300 basis points, according to a Bloomberg Intelligence analysis.
That increased rate premiums across the developing world and boosted the appeal of emerging-market assets. In Brazil, the central bank has boosted its selic rate by 725 basis points to 9.25%, while Chilean policy makers have increased their benchmark by 350 basis points to 4%. Since March 2020, the Fed has kept its target rate at a record low of 0.25%.
EM central banks have already responded to the run up in inflation after the Covid growth slump, and the tightening of monetary policy conditions have almost run its course in Latin America, said Anders Faergemann, a manager for emerging-market fixed income at PineBridge Investments in London. On a forward-looking basis, we believe that inflation will decline and converge toward official central bank inflation targets, meaning that the justification for further monetary policy tightening may cease. Chile is the biggest gainer among the 19 nations in the Bloomberg EM Local Currency Government Bond Index, with a return of 4.6% over the past three months, followed by Israel with 3.2% and China with 3%.
While local-currency bonds have prospered, their dollar-denominated cousins have been put under pressure by the looming Fed tightening. The U.S. central bank has sounded increasingly hawkish in recent weeks, with markets now pricing for a first rate hike in March. Demand for dollar debt is sapping because of the rapid inflation in the world's biggest economy. The consumer-price index rose to 7% in December, the highest level in almost four decades.
If currency valuations are taken into account, local-currency bonds could have more room to gain. The Brazilian real's effective exchange rate is 19% undervalued compared to its five-year average, while the Chilean peso is undervalued by 12% and Hungary's forint is 5%, according to data compiled by Bloomberg.
There are a lot of items on the economic calendar that will help determine the direction of emerging-market local and dollar debt in the week ahead. There will be Chinese economic growth data, South African inflation and rate decisions from Malaysia, Indonesia and Turkey.
Here are some of the major events and data in emerging markets this week:
On Monday, neither China will publish fourth-quarter GDP numbers, along with industrial-production and retail sales figures. Any disappointments in the data may add to speculation that the authorities will ease policy in the coming months to support the economy.
South Africa will not release December CPI figures on Wednesday after inflation in November surged to the highest level in almost five years in almost five years.
There will be no central banks in Indonesia and Malaysia will announce their policy decisions on Thursday, with economists saying they will keep rates at their current record lows. Malaysia will release December CPI on Friday.
Turkey s central bank has not met Thursday, after cutting policy rates by a cumulative 500 basis points over its four meetings since September.
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