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EM bonds get reprieve amid lower UST yields

Edward Bell - Senior Director, Market Economics
Published Date: 21 April 2021


Emerging market bonds have managed to piggy-back on the rise in US treasuries since the end of March. As 10yr UST yields have shed around 18bps from their year-to-date peak close of 1.74% on March 31st, both USD and local currency emerging market bond indexes have rallied. To us, the run-up in UST yields to more than 1.7% appears to have been too fast given that we expect bumps in inflation in Q2 are largely going to be driven by base effects, rather than unmanageable supply-side issues. However, for emerging market bonds to carry on with rallying we don’t believe they can rely on the current bear market rally in USTs indefinitely. Country-level risks, largely related to a worsening Covid-19 case load in many emerging markets, will weigh on growth.

Since 10yr USTs hit their peak at the end of March, the Bloomberg Barclays index of USD emerging market bonds has managed to gain 1.4% while the local currency alternative has added more than 2% in the same period.

EM bonds benefit from lower UST yields

Source: Bloomberg, Emirates NBD Research. Note: rebased to Jan 1 2021.

Within the EM universe we track, Turkish bonds have been a relative outperformer with 10yr yields down almost 80bps in April alone. However, that has barely made a dent in the surge in yields catalyzed by the dismissal of Naci Agbal and his replacement with Sahap Kavcioglu. While the new governor kept rates on hold at his first meeting in mid-April, seemingly to the relief of markets, the uncertainty on the outlook for monetary policy in Turkey will keep Turkish rates markets volatile in the near term.

In South Africa, bonds have clawed back a considerable portion of their year-to-date losses. Inflation is projected to come in at the middle of the SARB’s target range of 3-6%, allowing the central bank to maintain an accommodative policy stance. Moreover, with yields still above 9% South African bonds have been benefitting from overseas investor flows.

Indian bonds have been relative underperformers within the major EM space with yields falling by less than 10bps. At its April meeting the Reserve Bank of India announced it would effectively being a quantitative easing programme, buying up to INR 1trn while also keeping rates on hold.

Emerging market LCCY sovereign bonds get a boost in April

Source: Bloomberg, Emirates NBD Research. Note: 10yr government bonds. 

But while the bond market gains will no doubt be welcome in helping to tamp down borrowing costs, domestic economic challenges makes the outlook for further rallies difficult. India is in the midst of a parabolic rise in the number of Covid-19 cases and economically significant states across the country are reimposing lockdown conditions. Perhaps as an early warning signal, the INR has fallen more than 3% against the dollar in April alone, among the worst performing EM currencies and against the trend of most others which have actually appreciated this month.

EM currency performance vs USD

Source: Bloomberg, Emirates NBD Research

While global growth will certainly perform well this year thanks to outperformance in the US and Chinese economies in particular, the pace of expansion across emerging markets will be moderated by how effectively they are able to distribute Covid-19 vaccines and get economies to open up fully. The temptation to open up without proper vaccination or medical restrictions may end up being self-defeating. Moreover, the lull in UST markets may be temporary. We suspect markets are now blinking in the face of the Fed’s commitment to keeping rates on hold for the foreseeable future but as inflation is set to move higher in the next few data prints—even if we expect it will be mainly base effect driven—then a resumption in UST sell-off and higher EM yields may be not too far off in the distance. 

Vaccine distribution among major emerging market economies

Source: Our World in Data, Emirates NBD Research