Will the emerging market bond rally continue?

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Will the emerging market bond rally continue?

Published: Sun 21 Aug 2016, 5:04 PM

Last updated: Sun 21 Aug 2016, 7:18 PM

I have been bullish on emerging market debt as an asset class since last autumn. Even though the Chinese yuan devaluation was toxic, this asset class is up 12 per cent in 2016, thanks to almost $5 billion in cash inflows. The tax amnesty in Indonesia, the political changes in Brazil after President Dilma's impeachment, the election of a center-right pro-business government and $16 billion sovereign debt new issue in Argentina, the successful Reserve Bank of India (RBI)'s inflation targeting policies, the Thai military junta's successful referendum and the dramatic compression in sovereign debt spreads in Russia all contributed to the highly profitable performance of emerging market debt in 2016.
The Yellen Fed's reluctance to raise US interest rates despite strong US payrolls data and rising wage growth contributed to the record inflows in emerging market debt, as did the global obsession with yield in a world where the ECB, the Bank of Japan and the Bank of England are all engaged in quantitative easing while $12 trillion in fixed income securities sport negative yields.
The most successful emerging markets debt tracker in the world is the J.P. Morgan USD Bond exchange traded fund (symbol EMB), which has offered a 78 per cent total return since its launch in 2007, compared to a 18 per cent loss in MSCI emerging markets equities index. The most compelling reason to invest in this asset class was the near zero Fed Funds rate in the US since the Bernanke Fed slashed its policy rate after Lehman's failure in September 2008. This existential reality in the global debt market triggered a "hunt for yield" by retail investors that has seen emerging market debt index fund assets rise to $16 billion.
Of course, this asset class becomes leprosy if investors suspect that the Federal Reserve is about to tighten interest rates. In May 2013, when Ben Bernanke uttered the word "taper", a global sell off saw investors yank $3 billion from emerging markets debt as the J.P. Morgan index fund dropped 10 per cent in June and July 2013. A prospective Fed rate hike to investors in Third World debt, is akin to a cross of gold shown to Count Dracula at daybreak.
I am amazed that private banks in Dubai encourage investors to leverage emerging markets and corporate bonds on the eve of history's biggest debt market bloodbaths as the Yellen Fed reaches the limits of its dual mandate while the Western world abandons fiscal austerity for deficit spending. This could trigger another tsunami of tactical outflows in emerging market debt index funds. The J.P. Morgan emerging market index fund (symbol EMB) has a duration of 7.2 years, a disaster for investors if the Yellen Fed turns hawkish at Jackson Hole or the September FOMC. The J.P. Morgan EM index fund (symbol EMB) has risen from 103 in January to 118 now and its assets are now at a record $9.56 billion. It boasts a yield of 4.7 per cent and a Sharpe ratio of 1.97.
I have been hugely bullish long duration Argentine assets even before the election of President Mauricio Macri last November. The shares of Banco Macro, Argentina's largest publicly traded private commercial bank, returned 100 per cent since I recommended them in this column last October. So it was no surprise to me when President Macri negotiated a deal with holdout Paris Club creditors and paved the path for Argentina's historic $16 billion sovereign new issue. Argentina's bond rose from par to 112 in only four months. My bet on Argentine political risk was spectacularly profitable in both Banco Macro's New York shares (symbol BMA) and the Republic of Argentina sovereign debt. Yet political risk in this asset class can wipe investors out, as happened to a UAE family office owning Russian rouble debt after Putin invaded Ukraine and annexed the Crimea in March 2014. When emerging markets go ballistic, there is no place to hide! - business@khaleejtimes.com
 

By Matein Khalid

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