Debt switch primer: carry trades in 2013
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EM local-currency bonds have outperformed USTs since the announcement of QE3 in September, as reflected by the spread narrowing between the GBI-EM Global Diversified Index and USTs. Going forward, we see the scope for EM to continue outperforming USTs. Fe
Hence, we expect to see a period of lower volatility rangebound trading over the next couple of months, at least until after the US fiscal cliff situation has been resolved. Meanwhile, we expect investors to search for carry trades in emerging markets, which will benefit Asian bonds.
Our near-term economic outlook remains one of concern about the potential fiscal cliff facing the US economy. The planned fiscal deficit reduction of 4.7ppt of GDP in 2013 is a magnitude not seen since the aftermath of the Second World War, which is why a solution must be found.
Ben Bernanke has stated that if no action is taken, “the size of the fiscal cliff is so large that the Fed would have no ability to offset that effect”. While we expect that a compromise will be reached that sees the fiscal contraction spread over four years, a last-minute solution is the likely outcome, and this continues to hold a dark cloud over investor sentiment. So until this issue is addressed, investors will be shy from adding significant risk to their portfolios.
Since the start of September, foreign inflows into EM local-debt markets have picked-up by around US$11.8 billion versus total outstanding foreign holdings of $429 billion at the end of August. Our data set covers foreign holdings in Malaysia, Thailand, Korea, Indonesia, Brazil, Mexico, Turkey, Hungary, South Africa, Poland and the Philippines.
Within Asia, Indonesia saw foreign holdings rise by around $1.3 billion since the start of September compared to outflows of $540 million in August. Going forward, we expect foreign bond inflows to continue to gradually filter through into Asia, as investors continue to cling onto the carry trade theme.
But if Chinese economic data continues to stabilise and the yuan begins to strengthen, then we should see a sharp pickup in foreign bond inflows into Asia, as investors are still slightly underweight on Asian bonds versus being slightly overweight in CEMEA and LATAM.
In EM rates markets, monetary policy remains a key focus. In Asia, we expect further monetary easing in this cycle, which should be supportive of domestic investors’ demand for local bonds. We expect another cut of 25 basis points from Korea, and a 25 basis points cut from the Bank of Thailand in the fourth quarter. Elsewhere, we expect Bank Negara Malaysia (BNM) to keep rates on hold.
Malaysia’s headline CPI inflation continues to trend lower (at 1.4 per cent year on year in August), while domestic demand remains strong. Dovish monetary policies (with the exception of Indonesia) should sustain the demand for bonds by local investors.
Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank, based in Singapore.
