Where Can you Get Higher Bond Yields?

Summary

• US yields are rising on improved risk sentiment and growing optimism over a global recovery
• European yields have dropped lower with the ECB set to announce new stimulus next week
• Higher US yields raise questions over whether EM can sustain higher borrowing costs
• The low level of rates and a search for yield leave financing concerns some way off for most major EMs

Market Implications

• Rising inflows into EM have pushed yields lower and currencies stronger. But yield pickup remains attractive and far above that in DM.

US yields are rising. The combination of growing optimism over a global recovery given vaccine progress, and the possibility of a US stimulus package have boosted risk appetite. US equities have also reached new highs this week, oil is edging higher, helped by the OPEC+ agreement to delay output increases, and dollar weakness has gathered pace. By contrast, European yields have moved deeper into negative territory (Germany now back at -0.6% and France at -0.3%) with the ECB expected to announce further asset purchases next week.

Is this rise in US yields a concern for emerging markets? The post COVID world of higher debt levels leave the potential for financing costs to become problematic and interest bills taking an ever greater share of government spending. But we are not there yet. The very low level of US rates leaves the recent move higher of little concern. And the search for yield is still significantly in EMs favour.

Since our last bond yield report in October, yields in several of the highest yielders are actually lower. Turkish yields are off the recent highs (now 11.6%) following a shake-up at the central bank and finance ministry. The lira has now stabilized following a sizeable rate hike and investor confidence is improving. Yields in Indonesia are also lower (now 6.2%) following a surprise rate cut from BI. Mexican yields are 40bps lower, helped by recent good news on inflation and even India is lower by 10bps despite rate cuts delayed as inflation moved further above target.

Bumper inflows into EM are driving yields lower (and local equity markets higher). But one other consideration is the currency. CNH appreciation of 6.5% YTD on top of 3.3% on yields looks very attractive. FX gains in KRW and TWD also provide some juice to Asia’s low yielders. But for TRY and BRL where currencies have lost more than 20% YTD, current yields do not provide enough of an offset. The same can be said for Russia and South Africa. But if currencies stabilize after this year’s pronounced weakness EM bonds offer attractive returns.

Caroline Grady is Head of Emerging Markets Research at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)