Tide turning for emerging currencies, local debt

November 29, 2012

Emerging market currencies have been a source of frustration for investors this year. With central banks overwhelmingly in rate-cutting mode and export growth slowing, most currencies have performed poorly. That has been a bit of a dampener for local currency debt –  while returns in dollar terms have been robust at 13 percent, currency appreciation has contributed just 1.5 percent of that, according to JP Morgan.

 

 

The picture could be changing though.  Fund managers at the Reuters 2013 investment outlook summit this week have been unanimously bullish on emerging debt, with many stating a preference for domestic debt. So far this year, dollar debt has taken in three-quarters of all inflows to emerging fixed income.

Andreas Uterman, CIO of Allianz Global Investors told the summit in London that many emerging currencies looked significantly undervalued, and that this anomaly would gradually resolve itself:

Once the global economy starts to recover, it will be easier to bear appreciation of real exchange rates.

JP Morgan’s survey of 75 U.S.-based bond investors showed that the majority of investors plan to raise their allocation to emerging debt next year, with  local currency debt topping the list of preferences.  They targeted  7-10 percent returns on JPM’s GBI-EM local debt index,  outstripping the 5-7 percent expected of sovereign dollar debt.  Currency gains are expected to become a bigger driver of performance, accounting for half of next year’s GBI-EM returns, JPM reckons.

What will support currencies will be a shift in monetary policy focus. After this year’s swingeing rate cuts from Brazil to South Korea, EM central banks, according to JPMorgan, will raise interest rates next year by 8 basis points on average. Markets are pricing countries such as Brazil, Mexico and Chile to start tightening policy as early as the first half of 2013.

UBS too advises clients to load up on local currency debt; while not exactly enthusiastic about currency prospects,  it predicts more central banks to raise rates next year than cut them and is predicting 6-7 percent returns on EM currencies.

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