Emergence of Hard-Currency Bonds After a Slowing Rate Hikes

Wall Street banks are raising their estimate for emerging market hard currency bonds as a delay in U.S. rate increases may provide the troubled asset class some breathing room.

In what should have been one of the worst years for emerging markets, emerging market government bonds returned 20% negative despite rising inflation and aggressive rate hikes. After the release of the recent U.S. inflation statistics, JPMorgan (NYSE: JPM) upgraded its view for emerging market hard currency debt on Monday from “underweight” to “marketweight.”

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According to the report, the key factor driving E.M. markets lower is no longer greater inflation leading to an increase in the terminal Fed Funds rate, but rather growth and the possibility of a U.S. recession. In its 2023 projection, Morgan Stanley (NYSE: M.S.) forecasted that bonds denominated in hard currencies from developing markets might yield more than 14% in 2019.

In a note to clients, James Lord Morgan Stanley said: We’re entering the final week of 2022, which should be good for E.M. bond investors. “The forecast that global inflation would decline in 2023 is the primary call behind the positive total returns.” Money managers sold $86B worth of E.M. bonds, quadrupling the amount they sold in 2015 during the “taper tantrum” year, according to a new estimate by JPMorgan.

Data shows a smaller increase in U.S. consumer prices in October. Moreover, on Friday, the world’s financial markets received an apparent peak in underlying inflation well. Due to Citi’s more positive outlook on both emerging markets’ fixed income and developing currencies, the Fed may be able to scale back its significant interest rate increases. As a peak, U.S. Core CPI appears to have been reached. According to Dirk Willer, head of emerging market strategy at Citi Research, the Fed pivot story resurfaces in the bank’s weekly strategy note.