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The reflation euphoria has a dark side for emerging markets

"If a particular allocation across the risky markets spectrum should be low confidence this year, it is the EM overweight," JPMorgan's John Normand wrote in a note to clients on Wednesday

Topics
Emerging markets | Treasury gains | United States

Bloomberg 

emerging markets, development, people, growth, economy, traffic, hdi, developing
The danger for this notoriously volatile asset class is that inflation in the US is picking up again, and that’s driving benchmark rates higher

Rising Treasury yields risk pulling the rug out from under the rally in emerging markets, denting one of the street’s favorite trades of the year.

The prospect of a strong economic rebound and hefty US stimulus has strategists at Group Inc. and money- managers at Amundi lending their voices to the bull case in the developing world. But the rout in Treasuries that these forces have unleashed should keep investors on their guard, according to JPMorgan Chase & Co.

“If a particular allocation across the risky spectrum should be low confidence this year, it is the EM overweight,” JPMorgan’s John Normand wrote in a note to clients on Wednesday.

The danger for this notoriously volatile asset class is that inflation in the US is picking up again, and that’s driving benchmark rates higher. If the selloff runs further it could force investors who piled into higher-yielding securities in the developing world to head for the exit, as the relative appeal of holding them wanes.

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The 10-year Treasury yield rose to the highest level in a year this week, as investors started to price in the full economic impact of a stimulus plan totaling as much as $1.9 trillion. According to Sid Mathur, head of Asia Pacific research at BNP Paribas SA, the move could lead to quick repricing in emerging-market bonds as well.


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For Goldman, “a sharp move higher in US rates can drive sharp selloffs among highly-positioned high-yielding EM currencies on a tactical horizon,” strategists led by Kamakshya Trivedi wrote in a note Wednesday. These “moves can retrace once the pace of the rate move moderates,” they added.

Not everyone sees higher Treasury yields as a headwind for emerging markets, pointing to the fact that capital flows tend to accelerate as the global economy expands, outweighing the negative impact of higher borrowing costs.

“Relative to other fixed income assets, EM local currency bonds are better placed to weather the storm,” said Mark Baker, investment director for emerging-market debt in Hong Kong at Aberdeen Standard Investments, citing the relative cheapness of their currencies and attractive yield.

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First Published: Sat, February 20 2021. 00:33 IST
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