Emerging market bonds: peers show Powell better turn of speed

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Emerging market central bankers have shown up their counterparts in the west. The Federal Reserve raised rates to their highest level in 22 years on Wednesday. Fed chair Jay Powell’s peers to the south acted faster, unpersuaded by the idea inflation was transitory.

The Central Bank of Brazil, for example, lifted target rates a year before the Fed. Inflation in the country appears to be tamed and rate cuts are expected soon.

Investors in emerging market bonds are taking note. Inflation may now fall faster than emerging market central banks cut rates, generating steeper real yields on local debt.

Emerging market bonds have been the best-performing fixed income investments so far this year. That was reflected in recent results from Ashmore. The specialist asset manager added $1.1bn to assets under management thanks to good investment performance in June. But net outflows of $2.9bn more than offset the gains.

Dollar weakness is helping emerging market bonds. Against a trade weighted basket the reserve currency is now down 12 per cent since peaking last September. Currencies such as the Brazilian real, the Mexican and Colombian pesos, and the Polish zloty have all appreciated strongly against the dollar.

Spreads against US Treasuries are now at their highest levels since 2000. The best-performing currencies are likely to have peaked with local rates set to fall before any Fed cuts arrive. Structural changes underpin economic strength. Mexico is experiencing a strong reshoring effect while Brazil is pushing through the simplification of its tax system.

Inflation in the South American country was 3.2 per cent year on year in June, below the central bank target of 3.25 per cent. Target interest rates, meanwhile, remain at more than 13 per cent. Mexican inflation is also falling, down to 5 per cent year on year in June versus policy rates of more than 11 per cent. As reality sinks in longer-dated yields have begun to fall.

Ashmore shares have recently lagged behind the emerging market bonds they generally track. That creates an opportunity for bargain hunters.