Returns from emerging-market local-currency debt are trailing their dollar-denominated peers by the most in two years as resurgent inflation has damped the prospect of further interest-rate cuts in Latin America and Eastern Europe. At the same time, policymakers in emerging Asia have signalled an increasing unwillingness to ease policy before the Federal Reserve.
“I definitely think the easy money is gone,” said Robert Samson, a fund manager in Singapore at Nikko Asset Management, which oversaw $240 billion at the end of March. “Duration hasn’t really paid anywhere with curve inversion and the Fed higher for longer.”
The renewed hawkishness is upending a bet which earlier this year was hailed as a “once-in-a-generation” opportunity to buy emerging-market local debt. Not only has investor enthusiasm been damped by the diminishing prospect of rate cuts, but a supercharged dollar is dragging down developing-nation currencies.
Emerging-market local bonds have handed investors a loss of about 1% this year, after rallying by more than 6% in 2023, based on a Bloomberg index. In contrast, a corresponding gauge of dollar debt has returned 2.5% since the end of December.Amid the recent hawkish developments, Brazil’s inflation topped forecasts in May, while Mexico’s central bank said last month sticky prices pressures are a reason to be cautious about further easing. Meanwhile, Peru’s policymakers unexpectedly halted rate cuts last week amid concern about consumer prices.In Europe, Hungary’s central bank said it’s near the end of its easing cycle, while the Polish government’s wage plan may delay rate cuts. In Asia, Thailand’s policymakers kept rates on hold last week after inflation quickened, while their peers in Taiwan boosted the reserve requirement ratio for banks in a form of policy tightening.Fed Threat
Looming over all is the Fed’s higher-for-longer mantra that’s shrinking the scope for policy easing in emerging markets.
The Fed “is a significant headwind for progress in the second half,” said Rajeev De Mello, a global macro portfolio manager at GAMA Asset Management SA in Singapore. “All the central banks worldwide, even beyond EM, were hoping that in a way the Fed would help them out by sticking to the initial plans of cutting rates.”
The growing hawkish signs are already helping to trigger investor selling. The $2.7 billion VanEck JP Morgan EM Local Currency Bond ETF, the world’s largest ETF tracking developing-nation debt, has seen net outflows over the past three months, according to data compiled by Bloomberg.