Rate-hike bets in emerging markets getting excessive: funds

New York

WHEN it comes to betting on higher borrowing costs in the developing world, some investors may be getting ahead of themselves.

In markets from South Africa to Mexico and South Korea, traders are pencilling in a faster pace of interest-rate hikes than what economists say is currently warranted based on the inflation outlook.

"Almost all of them are overpricing tightening," said Shamaila Khan, head of emerging-market debt at AllianceBernstein in New York, whose US$4.7 billion high-yield bond fund has topped 86 per cent of peers in the past year.

The positioning reflects a common motif in markets: After months of Covid-19 lockdowns there's a risk that policy makers run their economies hot, only to backtrack with sharper-than-expected rate hikes down the line.

But the debate carries extra weight in emerging markets - an asset class that's particularly sensitive to the Federal Reserve's stance. It suggests how trades could quickly unwind on any signs of policy staying loose, potentially rewarding investors willing to look past the bearish outlook.

In Mexico, for instance, the swap-market pricing suggests a hiking cycle could start as soon as August, even though most economists say the central bank will refrain from tightening until at least February.

It's a similar story in South Africa, where forward-rate agreements are pricing in a 70 per cent probability of a 50-basis-point jump in six months, whereas Bloomberg's monthly survey shows the rate staying unchanged until year-end.

Meantime, South Korea's forward-rate agreements are pricing in close to a 25 basis-point rate increase in the next six months. In contrast, most economists predict no change.

Against this backdrop, AllianceBernstein's Ms Khan said her fund favours the local debt of South Africa, Mexico and Russia, "where markets have priced in too much in terms of the policy rate path".

US central bank officials may be able to begin discussing the appropriate timing of scaling back their bond-buying programme at upcoming policy meetings, Fed vice chair Richard Clarida said last week.

In India, traders unwound their rate-hike wagers last month as policy makers turned to a bond-buying program to support the economy against another wave of infections.

HSBC Holdings says the prospect that central bank support gets scaled back later than current market pricing implies suggest there's value in the front-end of the rates curve, including in South Korea and Poland.

Edwin Gutierrez, head of emerging-market sovereign debt at Aberdeen Asset Management in London, said: "We are long South Africa and Mexico as we do think that the curve prices in a rate hiking trajectory that is not likely," he said. BLOOMBERG