Global Investing

Tide turning for emerging currencies, local debt

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.

Emerging policy-Down in Hungary; steady in Latin America

A mixed bag this week on emerging policy and one that shows the growing divergence between dovish central Europe and an increasingly hawkish (with some exceptions) Latin America.

Hungary cut rates this week by 25 basis points, a move that Morgan Stanley described as striking “while the iron is hot”, or cutting interest rates while investor appetite is still strong for emerging markets. The current backdrop is keeping the cash flowing even into riskier emerging markets of which Hungary is undeniably one. (On that theme, Budapest also on Wednesday announced plans for a Eurobond to take advantage of the strong appetite for high-risk assets, but that’s another story).

So despite 6 percent inflation, most analysts had predicted the rate cut to 6 percent. With the central bank board  dominated by government appointees, the  stage is now set for more easing as long as investors remain in a good mood.  Rates have already fallen 100 basis points during the current cycle and interest rate swaps are pricing another 100 basis points in the first half of 2013. Morgan Stanley analysts write:

And the winner is — frontier market bonds

Global Investing has commented before on how strongly the world’s riskiest bonds — from the so-called frontier markets such as Mongolia, Nigeria and Guatemala — have performed.  NEXGEM, the frontier component of the bond index family run by JP Morgan, is on track to outperform all other fixed income classes this year with returns of over 20 percent., the bank tells clients in a note today. Just to compare, broader emerging dollar bonds on the EMBI Global index have returned some 16 percent year-to-date while local currency emerging debt is up 13 percent.

That appetite for the sector is strong was proven by a September Eurobond from Zambia that was 15 times subscribed. Demand shows no sign of flagging despite a default in frontier peer Belize and shenanigans over the payment of Ivory Coast’s missed coupons from last year. Reasons are easy to find. First, the yield. The average yield on the NEXGEM is roughly 6.5 percent compared with  just under 5 percent on the EMBIG.

Second, this is where a lot of issuance is happening as big emerging markets such as Brazil and Mexico, once prolific dollar bond issuers, sell less and less on external markets in favour of domestic debt.  Frontier markets are filling the gap. JPM says Angola, Guatemala, Mongolia and Zambia joined the NEXGEM in 2012 as they made their debut on global capital markets. Bolivia is also set for inclusion soon, taking the number of NEXGEM members to 23 by end-2012.

Emerging Policy-The inflation problem has not gone away

This week’s interest rate meetings in the developing world are highlighting that despite slower economic growth, inflation remains a problem for many countries. In some cases it could constrain  policymakers from cutting interest rates, or least from cutting as much as they would like.

Take Turkey. Its central bank surprised some on Tuesday by only cutting the upper end of its overnight interest rate corridor: many had interpreted recent comments by Governor Erdem Basci as a sign the lower end, the overnight borrowing rate, would also be cut. That’s because the central bank is increasingly concerned about the lira, which has appreciated more than 7 percent this year in real terms. But the bank contented itself by warning markets that more cuts could be made to different policy rates if needed (read: if the lira rises much more).

But inflation, while easing, remains problematic.  On the same day as the policy meeting, the International Monetary Fund recommended Turkey raise interest rates to deal with inflation, which was an annualised 9.2 percent in September. The central bank’s prediction is for a year-end 7 percent rate but that is 2 percentage points higher than its 5 percent target. So the central bank probably was sensible in exercising restraint.

Weekly Radar: Cliff dodging and Euro recessions

Most everything got swept up in the US election over the past week but, for all the last minute nail biting  and psephology, it was pretty much the result most people had been expecting all year. So, is there anything really to read into the market noise around the event? The rule of thumb in the runup was a pretty crude — Obama good for bonds (Fed friendly, cliff brinkmanship, growth risk) and Romney good for stocks (tax cuts, friend to capital/wealth, a cliff dodger thanks to GOP House backing and hence pro growth). And so it played out Wednesday. But in truth, it’s been fairly marginal so far. Stocks were down about 2 pct yesteray, but they’d been up 1 pct on election day for no obvious reason at all. But can anyone truly be surprised by an outcome they’d supposedly been betting on all along. (Just look at Intrade favouring Obama all the way through the runup). Maybe it’s all just risk hedging at the margins. What’s more, like all crude rules of thumb, they’re not always 100 pct accurate anyway.  Many overseas investors just could not fathom a coherent Romney economic plan anyway apart from radical political surgery on the government budget that many saw as ambiguous for growth and social stability anyhow.  Domestic investors may more understandably wring their hands about hits on dividend and income taxes, but it wasn’t clear to everyone outside that that a Romney plan was automatically going to lift national growth over time anyhow.

That said, it was striking on Wednesday that even though global funds were mostly relieved the Fed won’t now be shackled after 2014, nearly everyone still expects the fiscal cliff to be resolved by compromise. Whether that’s wishful thinking or the smartest guess remains to be seen. But, just like in Europe, it means they are at the very least going to have endure a barrage of political noise in headlines and endless scaremongering before any deal is ultimately forthcoming. Some say the nature of the GOP defeat, even with an incumbent saddled with an 8 pct unemployment rate, will force enough moderate Republicans to seek distance from Tea Party and seek compromise. But others point out that post-Sandy relief  spending may also bring the dreaded debt ceiling issue forward sooner than expected now too. All in all, the overwhelming consensus still betting on an eventual cliff dodge may be the most worrying aspect of market positioning and may be the best explanation the slightly outsize and sudden stock market reaction.

It also presupposes markets are trading solely on U.S. issues when the other world worries remain.

Emerging Policy-Hawkish Poland to join the doves

All eyes on Poland’s central bank this week to see if it will finally join the monetary easing trend underway in emerging markets. Chances are it will, with analysts polled by  Reuters unanimous in predicting a 25 basis point rate cut when the central bank meets on Wednesday. Data has been weak of late and signs are Poland will struggle even to achieve 2 percent GDP growth in 2013.

How far Polish rates will fall during this cycle is another matter altogether. Markets are betting on 100 basis points over the next 6 months but central bank board members will probably be cautious. Inflation is one reason  along with the  the danger of excessive zloty weakness that could hit holders of foreign currency mortgages. One source close the bank tells Reuters that 75 or even 50 bps would be appropriate, while another said:

“The council is very cautious and current market expectations for rate cuts are premature and excessive.”

INVESTMENT FOCUS-Bond-heavy overseas funds want Obama win

Overseas investors, many of whom are creditors to the highly-indebted U.S. government, reckon a re-election of President Barack Obama would be best for world markets even if U.S. counterparts say otherwise.

For the second month in a row, Reuters’ monthly survey of top fund managers around the world was evenly split when asked whether a win for incumbent Democrat Obama or Republican hopeful Mitt Romney in the Nov. 6 presidential poll would be good for global markets.

The split was clearly dependant on whether the asset manager was based in the United States or not. Domestic funds, by and large, tend to favour Romney; overseas investors Obama.

Survival of the fattest?

Is there room only for the biggest, most aggressively-marketed funds in crisis-hit Europe?

Europe’s ten best-selling funds have attracted nearly a third of net sales across bonds, equity and mixed assets so far this year, as the grey bars show in the following chart from Thomson Reuters’ fund research firm Lipper.

TEN MOST SUCCESSFUL FUNDS’ NET SALES AS A PROPORTION OF ALL SALES

The numbers — which exclude ETFs — are even more staggering if looking at at the concentration of sales into groups/companies, rather than at fund level.

Chaco signals warning for Argentina debt

A raft of Argentine provinces and municipalities suffered credit rating downgrades this week after one of their number, Chaco, in the north of the country, ran out of hard currency on the eve of a bond payment. Instead it paid creditors $260,000 in pesos. Now Chaco wants creditors to swap $30 million in dollar debt for peso bonds because it still cannot get its hands on any hard currency.

The episode is a frightening reminder of Argentina’s $100 billion debt default 10 years ago and unsurprisingly has triggered a surge in bond yields and credit default swaps (CDS). But broader questions also arise from it.

First, will debt “pesification” by some Argentine municipalities snowball to affect international bonds as well? And second, is municipal debt likely to become a problem for other emerging markets in coming months?

Record year for emerging corporate bonds

The past 24 hours have brought news of more fund launches targeting emerging corporate debt;  Barings and HSBC have started a fund each while ING Investment Management said its fund launched late last year had crossed $100 million.  We have written about the seemingly insatiable demand  for corporate emerging bonds in recent months,  with the asset class last month surpassing the $1 trillion mark.  Data from Thomson Reuters shows today that a record $263 billion worth of EM corporate debt has already been underwritten this year by banks, more than a fifth higher than was issued in the same 2011 period (see graphic):

The biggest surge has come from Latin America, the data shows, with Brazilian companies accounting for one-fifth of the issuance. A $7 billion bond from Brazil’s state oil firm Petrobras was the second biggest global emerging market bond ever.

The top 10 EM corporate bonds of the year:  Petrobras issued the two biggest bonds of $7 billion and $3 billion, followed by Venezuela’s PDVSA and Indonesia’s Petramina. Brazil’s Santander Leasing was in fifth place, Mexican firms PEMEX and America Movil were sixth and seventh.  Chilean miner CODELCO, Brazil’s Banco do Brasil and  Russia’s Sberbank also entered the list.