Local Bonds’ Decade-Long Detour
JP Morgan’s 10th local bond market guide profiling currencies and fixed-income in dozens of countries traced continued evolution but acknowledged “mounting headwinds” into 2015 with this year’s performance negative in dollar terms until recently. The asset class is sensitive both to the greenback’s surge and expectations of US Treasury yields toward 3 percent in consensus forecasts following the Fed’s latest meeting direction. It has only recovered half the yield spread of the external sovereign and corporate categories prior to 2013’s taper tempest and the meager 1 percent gain projected this year will come entirely from carry, the bank believes. Hedging has been at historic lows as one-fifth of funds that fled since last May have not returned in contrast with hard currency recovery and overall positive EM bond allocation unlike equity. Through September $4 billion in outflows persisted with Japanese retail investors particularly averse. By region EMEA has suffered the greatest blow with Russia’s total just $1 billion in the first half compared to $10 billion-plus averages. Geopolitics is a drag but the lack of domestic insurance and pension fund sponsorship also contributes. The ECB’s creeping QE has boosted currencies against the euro, but the real exchange rate appreciation trend the past decade has waned on souring economic and technical risk measures despite resumed reserve increase to almost $10 trillion for the tracked universe. Forex bid-offer ratios have stabilized, and local bonds’ portion has held steady at over 60 percent of $1 trillion quarterly trading, according to EMTA, with instruments from Mexico, Brazil, India and South Africa in the lead. Central bank intervention has been modest this year and concentrated in big markets like Brazil, Turkey and Korea. Russia despite its wartime support reiterates a free-float objective, and Colombia and Peru have been active among second-tier economies as foreign positioning has grown. Related macro-prudential controls have also been “dialed down” with Ghana an example of reducing previous restrictions after entering IMF program talks. Total domestic debt rose $1 trillion from end-2013 to near $9.5 trillion, divided 55-45 between government and company. Corporate issuance through Q3 was $420 billion, one-third more than the international version. Fixed-rate paper is the norm and Latin American and Asian markets are the largest, with no European one above $200 billion.
The corporate segment has tripled post-crisis dominated by China, India, Korea and Malaysia with the first two cramping overseas investor access. Liquidity is also scarce due to the buy and hold nature and maturities tend to be less than 10 years. Few offerings are on Euroclear and dealing and settlement infrastructure otherwise is lacking, JP Morgan comments. Inflation-linked bonds outstanding are over $650 billion, with 80 percent from Latin America. Private pension funds there have assets above that amount as a captive fixed-income base, while Asian life insurers control $3 trillion with Hong Kong and Thailand expanding 10 percent annually. Together the contractual savers manage $1 trillion in EMEA, half in Israel and South Africa as Poland’s post-communist pools were drained in the swerving saga.
