Global Investing

Dollar drags emerging local debt into red

Victims of the dollar’s strength are piling up.

Total returns on emerging market local currency bonds dipped into the red for the first time this year, according to data from JPMorgan which compiles the flagship GBI-EM global diversified index of domestic emerging debt. While the EMBI Global index of sovereign dollar debt has already taken a hit the rise in U.S. yields, local bonds’ problems are down to how EM currencies are performing against the dollar.

JPMorgan points out that while bond returns in local currency terms, from carry and duration, are a decent 1 percent, that has been negated by the 1.3 percent loss on the currency side. With the dollar on the rampage of late  (it’s up almost 4 percent in 2013 against a grouping of major world currencies) that’s unsurprising. But a closer look at the data reveals that much of the loss is down to three underperforming markets — South Africa, Hungary and Poland. These have dragged down overall returns even though Asian and Latin American currencies have done quite well.

The graphic below shows South African local debt bringing up the bottom of the table, with the FX component of returns at around minus 9 percent  In rand terms however the return is still in positive territory, but only just. Hungary and Poland fare only slightly better.

Many bond positions are of course hedged. But as we wrote here yesterday  in an article on South Africa, escalating currency weakness can trigger exits from local bond markets.  And worryingly, JPMorgan notes that returns in local currency terms have plateaued at 1 percent over the past 10 days.

Hungary’s forint and rate cut expectations

A rate cut in Hungary is considered a done deal today. But a sharp downward move in the forint  is making future policy outlook a bit more interesting.

The forint fell 1.5 percent against the euro on Monday to the lowest level since July and has lost 2.6 percent this month. Monday’s loss was driven by a rumour that the central bank planned to stop accepting bids for two week T-bills. That would effectively have eliminated the main way investors buy into forint in the short term.   The rumour was denied but the forint continues to weaken.

Analysts are not too worried, attributing it to year-end position squaring. Benoit Anne, head of EM strategy at Societe Generale, points out the forint is the world’s best performing emerging currency of 2012 (up  11.3 percent against the dollar). Given the state of the economy (recession) and falling inflation, the forint move will not deter the central bank from a rate cut, he says.

Interest rates rise in Kenya, Uganda. Hungary next

Recent weeks have witnessed an interesting  split between countries that are raising interest rates to fend off runs on their currencies, and those cutting rates to spur on growth — check out my colleague Carolyn Cohn’s recent piece on this topic (http://tinyurl.com/4x58ny6) .The frontier economies of Africa fall into the first category — Kenya this week jacked up rates by an unprecedented 550 basis points to ward off a currency collapse, while Uganda’s benchmark rate was increased by 300 bps.  

Big stable economies such as Australia, Brazil and Indonesia have cut interest rates. On Wednesday, Romania became the latest  country to do so.  But an exception is investment grade Hungary, which may soon join the ranks of  frontier markets in currency-defensive rate hikes.

It may also soon lose its investment grade status –at least one of the three big rating agencies is expected to soon announce a cut to the sovereign credit rating.  That fear has triggered flight from the forint and short-dated bonds, pushing the currency to 2-1/2 year lows and causing significant flattening in the yield curve. The situation hasn’t been helped by signs the government is cooking up another sceme to subsidise indebted small businesses. More is to come, many predict –a ratings downgrade could see investors pull at least $1.2 billion euros from local bond markets. ING Bank estimates. That would be 10 percent of foreigners’ Hungarian bond holdings and would send the currency into a fresh tailspin.