Investors are raising the stakes for emerging-market central banks, rewarding those doing the most to prevent inflation from becoming more than transitory.
With inflation in developing nations now exceeding expectations by the most in more than a decade, assets backed by policy makers who are getting ahead of price pressures are enticing fund managers more than ever. Enter Russia and South Korea, whose currencies pulled ahead of most of their peers last month and whose longer-dated bonds have steadily outperformed their shorter-maturity counterparts since June.
“The proactive-tightening central banks could be rewarded with currency outperformance,” said Alan Wilson, a London-based money manager at Eurizon SLJ Capital. “Alpha opportunities do exist within our asset class, particularly when monetary policy is diverging.”
Surging prices threaten to eat into the yield premium that emerging markets offer over their developed peers, a key attraction for local and foreign investors alike. Data this week from Russia, South Korea and Colombia may provide further clues on the longevity of the rise in consumer prices, giving investors more reason to pick out the victors of the inflation battle.
Russia’s long-dated bonds are earning the faith of investors after policy makers delivered six rate hikes this year, with 10-year yields falling below their shorter-maturity counterparts last week for the first time since 2017. The inversion occurred as traders priced in a period of high rates following the central bank’s bigger-than-expected hike in October. Meanwhile, the ruble delivered its best monthly gain in almost a year.
In South Korea, longer-maturity bonds have also outperformed shorter ones, with the spread between 10-year and three-year securities falling to the lowest since March 2020. The Bank of Korea’s determination to pursue higher rates puts it at the forefront of Asia’s monetary tightening following its August hike, helping the won outpace most Asian peers in October.
“Bond markets in Korea and Russia are now increasingly overpricing medium-term inflation risk,” said Manik Narain, head of emerging-market cross-asset strategy at UBS Group AG in London.
At the other end of the spectrum, the currencies of Turkey and Brazil were the worst performers in October while their yield curves steepened.
Two consecutive surprise rate cuts since September sent the lira to record lows, pressured by Turkish President Recep Tayyip Erdogan’s demands for lower borrowing costs, which he says will slow inflation.
Meantime, the Brazilian government’s plans for greater public spending are undermining the central bank’s efforts to rein in prices despite embarking on the world’s most aggressive tightening this year.
“As important as central bank credibility is in fighting inflation, there also has to be a consistency between fiscal and monetary policy,” said Francesc Balcells, London-based chief investment officer of emerging-market debt at FIM Partners. “The market will punish either particularly if fiscal is vulnerable to begin with, which is the case in Brazil, or if monetary policy is completely out of whack, which is the case in Turkey.”
These are the events and data to look out for this week:
- Central-bank meetings in Poland and the Czech Republic will be closely watched as their currencies trailed the majority of developing peers in October despite recent rate increases. Their real rates remain negative amid a surge in inflation
- Poland’s central bank will likely deliver another rate hike on Wednesday following an unexpected tightening in October
- Czech policy makers are also set to lift borrowing costs on Thursday
- Malaysia is expected to keep its benchmark rate unchanged Wednesday after the government announced last week a record spending plan for 2022 to revive its virus-battered economy
- Brazil’s central bank will publish on Wednesday the minutes of last week’s meeting when it delivered its biggest interest-rate hike in almost two decades
- In Turkey, data on Wednesday will probably show consumer-price inflation accelerated to more than 20% in October amid a resurgence in energy costs and a weakening currency
- Purchasing managers’ indexes across emerging markets, including South Africa and Brazil, will show to what extent economies are recovering from the coronavirus shock
- China’s factory activity contracted for a second straight month in October, as electricity shortages and soaring commodity prices continued to weigh on manufacturers, data on Sunday showed
- Manufacturing activity in Asia outside China firmed last month, data showed Monday, as looser movement restrictions allowed factories to catch up ahead of the crucial year-end holiday season. Vietnam showed the largest improvement, while Indonesia had the region’s best reading
