Standout emerging-market bond bet set for another boost in 2024

Local bonds from emerging markets are luring investors, who are looking to profit from what they expect to be hefty returns thanks to shifting monetary policy paths.

Central banks in many developing economies have sped ahead in the fight against inflation, hiking — and then cutting — interest rates far faster than their policymaking peers in the US and Europe. That’s helped fuel what’s set to be the best annual rally in Latin American domestic bonds since 2009.

Now, Pacific Investment Management Co is among those preparing for another windfall in 2024. Speculation that the Federal Reserve will cut rates in the coming year, dragging the US dollar lower, should open the door to even looser policy in emerging markets and boost local asset returns.

“The closer we get to the Fed rate cut, the more investors will tilt toward local currencies,” said Ricardo Navarro, head of Latin American fixed income at Itau Unibanco Holding SA. “Investors want yield pick-up, and the thesis there is that without the Fed hiking further, you might as well get the bigger yield in EM currencies.”

That call comes after a standout year for Latin American local bonds. A Bloomberg gauge of local-currency government debt in the region has posted a 24% rally, as of December 7, compared to a 10% surge for similar dollar-denominated debt. The Colombian and Mexican pesos are the top two best-performing currencies in emerging markets this year.

Those gains have been trailed by the rest of the emerging world, where central banks have been slower in their monetary cycles.

Domestic debt from Europe, the Middle East and Africa is down 0.4% this year. The Turkish lira, Russian ruble and South African are so far among some of the worst-performing emerging currencies of 2023. Local Asian government debt, meanwhile, has returned about 2.4%, according to data compiled by Bloomberg as of December 7.

Thierry Larose, a money manager at Vontobel Asset Management AG in Zurich, said he favors Latin American local debt, but still finds opportunity in other parts of the world. He likes Czech and Hungarian rates, on a partially currency-hedged basis, thanks to their duration rather than their carry offerings. In South Africa, Larose said there’s room to make a tactical play and fade excessive exuberance or pessimism.

“Turkey could be the story of 2024,” said Larose, whose sustainable local-currency bond fund has outperformed 91% of peers over the past year, according to data compiled by Bloomberg. “The new economic team is well respected, has credible objectives to fight inflation and they communicate it in a clear and pragmatic way.”

Pimco’s head of emerging-market debt, Pramol Dhawan, has been touting the asset class as a top pick for 2024.

“We continue to be bullish,” said Dhawan, whose emerging-market local currency and bond fund has outperformed 95% of peers in the past year. “In fact, even more bullish now”

There is, of course, always the potential for volatility along the way. Traders on Friday pared back their expectations for the Fed to ease monetary policy aggressively next year after a better-than-forecast US jobs report.

Now, investors are looking ahead to the Fed’s final policy meeting of the year, and while no change in rates is expected, officials Wednesday will update their projections for 2024 for the first time since September.

As long as the Fed’s rate cute do ultimately materialize, though, strategists at Goldman Sachs Group Inc. said Latin America’s rate complex should see more support, with scope for meaningful rate relief in Mexico and Brazil.

The firm also like currency-hedged front-end bonds in China in anticipation of expected policy easing and long-end bonds in Poland and the belly of Hungarian rates. And India offers opportunity as its notes move into major indexes, a group led by Andrew Tilton wrote in a 2024 outlook note.

Solid demand

For emerging-market governments in need of financing, there’s an added bonus to increased demand for local assets.

With global monetary conditions still tight, borrowers and investors have turned to alternative sources of funding, such as loan syndication, conservation-linked securities and, of course, local-currency bonds.

The finance minister in Peru, for instance, has said the nation is eager to raise longer-dated, local currency-debt and using the proceeds to pay down some of the nation’s outstanding overseas notes.

And corporate activity has been rampant in Mexico’s domestic bond market — a trend that’s set to spill into 2024, according to Banco Santander SA. Lira-denominated Turkish government bonds, meanwhile, have been rallying, fueled in part by an increase in offshore buying.

“I think it’s healthier to rely on its local investor base and in a currency that is under your control,” said Vontobel’s Larose.

In all, emerging-market governments and companies have sold some $1.5 trillion worth of domestic debt so far this year, a 4% increase compared to the same period of 2022, according to data compiled by Bloomberg.

Issuance was led by Chinese, South Korean and Indian borrowers, the data show, though Brazil, Russia, Thailand and Saudi Arabia also ranked among the most-active local primary markets.

“There are windows of opportunity in local-currency sovereign issuance,” Itau’s Navarro said. “The sovereign issuers are going to lead the market at least for the first half of 2024.”

What to watch

• Across Wall Street, traders will watch as the Fed, European Central Bank and Bank of England make policy announcements in the coming week.
• Investors will closely watch for any major announcements on what comes next for Argentina after Javier Milei is officially sworn in as president on Dec. 10.
• In Brazil, the central bank will hold its final monetary policy meeting of the year. There’s broad consensus on a 50-basis-point rate cut to 11.75%.
• Bloomberg Economics expects Mexico’s policymakers to hold the benchmark rate at 11.25% at their December meeting and keep a cautious tone. They see Peru’s central bank cutting the policy rate to 6.75%.
• The Bank of Russia may hike the policy rate by 100 basis points to 16% on December 15, according to Bloomberg Economics.
• Central bank meetings in Pakistan and the Philippines will probably result in decisions to keep rates unchanged.
• Inflation data is set to come out from Brazil, Argentina, South Africa, India and China.

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