Emerging markets today aren’t the same as they were in 2013, argue portfolio managers at AGF
While the U.S. Federal Reserve has confirmed its intentions to begin winding down its US$120-billion-a-month bond-buying program as early as next month, investors should not be overly worried about a potential repeat of 2013’s taper tantrum.
That’s according to Tom Nakamura and Tristan Sones, vice presidents and portfolio managers at AGF Investments, who shared their views in a recent blog post.
According to the duo, the prospects of EM assets getting slammed by skyrocketing U.S. short-term rates and a soaring U.S. dollar aren’t so strong this time around.
“[T]he Fed has telegraphed its intentions for months now, and investors have largely not interpreted its signals as a dramatic change in direction that may significantly impact global liquidity conditions,” they said.
Beyond the relatively calm reaction among investors thus far, they said EM bond yield curves today are almost ubiquitously much steeper than they were in 2013. With the continued impact of COVID-19 and rising inflation expectations – among developing nations, that’s been fuelled by global growth and a pick-up in commodity prices – EM central banks have been raising rates, prompting bond markets to push up long yields.
“[T]he difference between two-year/10-year spreads in 2013 and today is more than 250 basis points in South Africa and Colombia, more than 100 basis points in Chile, and more than 70 basis points in Peru, Mexico, Malaysia, Indonesia and South Korea, among others,” they said, citing their findings from analysing Bloomberg data. “Steeper yield curves should help cushion those markets from higher short-term yields as the taper evolves.”
The higher long yields, Nakamura and Sones added, are also rewarding investors as they take on not just inflation risk, but also risks of pandemic flareups and credit concerns in certain cases among emerging markets. They also noted that domestic ownership of EM bonds is much higher as a percentage of the total bond market, as per Deutsche Bank research, which suggests a lower risk of a tantrum developing as foreign bond owners make a mad dash for the exits.
Finally, they noted that before 2013, the U.S. dollar had been in a devaluation cycle, which only reversed as the taper tantrum commenced. But today, the greenback is quite strong relative to EM currencies, which have only recovered slightly from the massive blow they were dealt as COVID-19 fears spiked last spring.
The two acknowledged that large central banks could be forced to hike rates more aggressively, assuming they fail in their bid to stare down the spectre of inflation. EMs could also be hit with another COVID-19 wave as liquidity dries up, they added.
But those two scenarios are unlikely to occur simultaneously, they argued, as central banks would be forced back into the sidelines if the pandemic were to pick up. Many EM countries have also seen significant improvements in their current account positions since 2013, according to HSBC research, which means they have more of a cushion against currency depreciation and economic volatility, at least temporarily.
“We would also point out that EM currencies can do quite well in periods when yields are rising, as long as those increases are underpinned by strong global economic growth – which could well characterize the current environment, barring another pandemic setback,” they said.
While the U.S. Federal Reserve has confirmed its intentions to begin winding down its US$120-billion-a-month bond-buying program as early as next month, investors should not be overly worried about a potential repeat of 2013’s taper tantrum.
That’s according to Tom Nakamura and Tristan Sones, vice presidents and portfolio managers at AGF Investments, who shared their views in a recent blog post.
According to the duo, the prospects of EM assets getting slammed by skyrocketing U.S. short-term rates and a soaring U.S. dollar aren’t so strong this time around.
“[T]he Fed has telegraphed its intentions for months now, and investors have largely not interpreted its signals as a dramatic change in direction that may significantly impact global liquidity conditions,” they said.
Beyond the relatively calm reaction among investors thus far, they said EM bond yield curves today are almost ubiquitously much steeper than they were in 2013. With the continued impact of COVID-19 and rising inflation expectations – among developing nations, that’s been fuelled by global growth and a pick-up in commodity prices – EM central banks have been raising rates, prompting bond markets to push up long yields.
“[T]he difference between two-year/10-year spreads in 2013 and today is more than 250 basis points in South Africa and Colombia, more than 100 basis points in Chile, and more than 70 basis points in Peru, Mexico, Malaysia, Indonesia and South Korea, among others,” they said, citing their findings from analysing Bloomberg data. “Steeper yield curves should help cushion those markets from higher short-term yields as the taper evolves.”
The higher long yields, Nakamura and Sones added, are also rewarding investors as they take on not just inflation risk, but also risks of pandemic flareups and credit concerns in certain cases among emerging markets. They also noted that domestic ownership of EM bonds is much higher as a percentage of the total bond market, as per Deutsche Bank research, which suggests a lower risk of a tantrum developing as foreign bond owners make a mad dash for the exits.
Finally, they noted that before 2013, the U.S. dollar had been in a devaluation cycle, which only reversed as the taper tantrum commenced. But today, the greenback is quite strong relative to EM currencies, which have only recovered slightly from the massive blow they were dealt as COVID-19 fears spiked last spring.
The two acknowledged that large central banks could be forced to hike rates more aggressively, assuming they fail in their bid to stare down the spectre of inflation. EMs could also be hit with another COVID-19 wave as liquidity dries up, they added.
But those two scenarios are unlikely to occur simultaneously, they argued, as central banks would be forced back into the sidelines if the pandemic were to pick up. Many EM countries have also seen significant improvements in their current account positions since 2013, according to HSBC research, which means they have more of a cushion against currency depreciation and economic volatility, at least temporarily.
“We would also point out that EM currencies can do quite well in periods when yields are rising, as long as those increases are underpinned by strong global economic growth – which could well characterize the current environment, barring another pandemic setback,” they said.
