Local Bonds’ Long Term Loss Lull
The latest edition of JP Morgan’s local bond market guide coincided with a Q1 index upswing over 10 percent in dollar terms, breaking a negative string since the 2013 Federal Reserve taper tantrum despite an average annual 7.5 percent gain the past dozen years. Currency fluctuation rather than carry has been the main loss component, and the Sharpe ratio over time has been roughly the same as other global asset classes. The average yield is now 6.5 percent and commodity exporters in Latin America have been the worst performers, while importers in good current account positions like Poland and the Philippines led advancers. Real effective exchange rates by standard formulas peaked a year ago, and returns should stay positive but may flag in coming months with budget and balance of payments deficits across a country swathe. Since the 2008 crisis government domestic debt has risen 12 percent to 45 percent of GDP, and at over $6 trillion local bonds are almost half the developing market debt universe. China alone is $1.5 trillion, almost the same as in all Latin America with Brazil $1 trillion of that amount. India, Korea and Mexico range from $350 billion-$700 billion, and Turkey is the largest Europe location at $150 billion. The GBI-EM benchmark comprises 15 countries with $900 billion outstanding, and gross issuance was near $1.5 trillion in 2015, 60 percent from the top five markets. This year volume will be steady but Asia’s share should increase outside China, according to the publication.
Local banks, pension funds and insurers are the majority investors, but foreign ownership is close to $600 billion or 30 percent of the total on average. In Brazil holdings declined 15 percent since 2013, while they doubled in Colombia and the Czech Republic. Local debt fund outflows persisted over Q1 at -3.5 billion and were offset by hard currency inflows, for a $1 billion overall allocation in comparison with the record $15 billion exit last year. Dedicated positioning remains underweight, and the domestic portion of fixed-income portfolios has dropped to 40 percent. New market expansion has generated interest and may eventually warrant index inclusion, with Vietnam, Sri Lanka, Croatia, Kenya and Argentina on the list. Bid-offer spreads have widened reflecting business and regulatory constraints on market-makers, and Brazil, Mexico and India instruments were the most frequently traded in EMTA’s latest survey. Currency pegs continue to be adjusted or broken, with further devaluation likely for Egypt’s pound and Nigeria’s naira.
Inflation-linked bonds are popular in Israel, Turkey, Chile and Colombia at one-fifth or more of the total, and in Asia Korea and Thailand have launched activity. Corporate bond stock including state-related and policy issuers approaches $6 trillion as well, with quasi-sovereigns half the universe dominated by China. Liquidity and access are limited in the large Asian markets with capital controls in place and the absence of Euroclear tie-up. Domestic bank loans far exceed bonds with corporate and household lines at 85 percent of GDP. In the Middle East Morocco and Tunisia retain overall foreign investor restriction, while Colombia’s tax regime is among the most onerous, with separate transaction and 15 percent withholding and capital gains levies despite a respite from even harsher earlier treatment.
