Currency rally drives sizzling returns on emerging local debt
Emerging market bonds denominated in local currencies enjoyed a record January last month with JP Morgan’s GBI-EM Global index returning around 8 percent in dollar terms. Year-to-date, returns are over 9.5 percent.
This is mainly down to spectacular gains on emerging currencies such as the Mexican peso and Turkish lira which have surged 7-10 percent against the dollar and euro this year. Analysts say the currency component of this year’s returns has been around 7 percent, meaning any portfolio hedged for currency risk would have garnered returns of just 2.5 percent.
The gains come as good news to investors licking their wounds after the index ended 2011 in negative territory. A mid-year rout on emerging markets pushed up local bond yields, often by hundreds of basis points and sent many currencies to multi-year lows.
Now, promises of more cheap cash from Western central banks has changed the mood, driving currency rallies. Adding to the optimism is the hope of more interest rate cuts in emerging markets, where inflation has peaked and growth is slowing.
It is unlikely however that such gains on local currency debt can be sustained. Already many countries are moving to stem currency appreciation — Brazil for instance last week resumed purchases of dollar forwards to curb the real’s gains against the dollar.
And interest rate cuts, hopes of which have been driving down short-dated bond yields, might not materialise, as inflation is running above-target almost everywhere.
Easing policy looks out of question for now in Turkey, Poland, Hungary and India. Chile and Russia, which were widely expected to cut rates further, are now seen more likely to hold steady. And Goldman Sachs said on Tuesday it no longer expects any more rate cuts this year in Malaysia, Indonesia, South Korea, Thailand or the Philippines, largely because of an improved economic outlook in the euro zone and the United States.