After bumper 2012, more gains for emerging Europe debt?
By Alice Baghdjian
Interest rate cuts in emerging markets, credit ratings upgrades and above all the tidal wave of liquidity from Western central banks have sent almost $90 billion into emerging bond markets this year (estimate from JP Morgan). Much of this cash has flowed to locally-traded emerging currency debt, pushing yields in many markets to record lows again and again. Local currency bonds are among this year’s star asset classes, returning over 15 percent, Thomson Reuters data shows.
But the pick up in global growth widely expected in 2013 may put the brakes on the bond rally in many countries – for instance rate hikes are expected in Brazil, Mexico and Chile. One area where rate rises are firmly off the agenda however is emerging Europe and South Africa, where economic growth remains weak. That is leading to some expectations that these markets could outperform in 2013.
There have already been big rallies. Since the start of the year, Turkey’s 10 year bond has rallied by 300 basis points; Hungary’s by almost 400 bps; and Poland’s by 200 bps. So is there room for more.
Analysts at Societe Generale reckon central banks in emerging countries – particularly in Europe - will ease policy further next year though they do not expect the same magnitude of gains as in 2012. Swaps markets are pricing 125 bps in rate cuts in Hungary and Poland over the next six months and around 50 bps in Russia, Turkey and South Africa.
Gaelle Blanchard, emerging markets strategist at the bank says:
There is a little bit of room for more downside on the yields (in emerging Europe), at least at the beginning of the year... There are some differentiations on countries but clearly the easing cycle is not over in most countries. In Hungary there are more rate cuts in the pipeline… In Turkey, they have done lots and lots already but I think the central bank is still dovish.
JP Morgan estimates monthly cash flows from foreign investors into EMEA emerging bond markets averaged $3.3 billion this year but its monthly survey still revealed investors holding a small underweight. That is likely to be a supportive factor, at least in the short-term, it says.
We change our view of EMEA emerging Local Market technicals to positive given two months of small improvements, tipping the balance, with investors underweight and local currency and EM equity fund inflows supportive.