Examining the drivers of local debt in emerging markets | Awareness

This analysis was conducted by Bloomberg Intelligence Chief EM Credit Strategist Damian Sassower. It first appeared on Bloomberg Terminal.

Emerging market debt has gotten off to a good start in 2019, with foreign borrowers benefiting from lower yields and a weaker dollar. Longer should continue to support EM government bond yields, as slower growth and a slower rate of growth begin amid widening differences in yield.

Local EM bonds started well from 2019

EM local currency debt is off to a strong start to 2019, as yields fall and the dollar’s oil price declines for the year. Slower growth and higher inflation expectations have resulted in a period (orange) gain of 181 bps per year, with 15 of the 18 countries contributing positively during this period. Appreciation of the local currency (blue) is another position of 182 bps of positive information, but only 11 of the 18 currencies that have risen this year against the greenback. Carry has risen sharply in recent quarters and now stands at 324 bps year-on-year.

Length measures the level, direction and shape of the local government yield curve. Income reflects changes in performance due to foreign currency movements. Carry refers to the amount of the coupon.

Time starts to bring local EM loans

The longer term should continue to be positive for EM bond yields as growth slows and inflation starts amid a widening gap in yields. EM central banks have raised interest rates by a combined 11,120 bps since tightening began in 3Q20, leaving local yields unchanged in Chile, the Czech Republic, Hungary, Israel, Mexico and Poland. Indonesia (52 bps) has contributed the most to the return since this year, followed by Brazil (45 bps), Colombia (36 bps), Poland (20 bps) and Malaysia (19 bps).

The relationship between US yields and EM local-debt activity is strong, as the return contribution over time (movement of local yields) shows a correlation of 85.1% to the 10-year Treasury (r-squared: 72.4%), from to 10 years of daily life.

Yuan weakness leaves EM currencies vulnerable

Continued dollar-yuan strength keeps Asian currencies in a fix, yet the US’s downward spiral is supporting a growing foreign exchange market. Since hitting record lows in October, the Bloomberg EM Equal-Weight Spot FX Index is up 7.8%, with high yields (such as the Hungarian forint, Chilean and Colombian pesos) leading the way. EM currencies are now performing well over the past year, with the Turkish lira (down 36.1%), the South African rand (down 14.1%), the Chinese yuan (down 7.8%) and the Israeli shekel (down 6.4%) trailing their peers.

The relationship between the US dollar and the EM performance on local debt will remain strong, as the return contribution from currency movements shows a correlation of 86.3% with the Bloomberg Dollar Spot Index (r-squared: 74.4%), based on 10 years of daily data.

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