Inflation drives investors away from Asian emerging market bonds

(Bloomberg) — Bond investors are avoiding emerging Asian markets as the region’s resilience to the global inflationary threat shows signs of cracking.

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Abrdn plc has been underweight Asian debt and SEB AB has become more cautious, while Goldman Sachs Group Inc. sees an incipient rate hike cycle to deal with pricing pressures flattening its yield curves the most globally in development. Asian sovereign bonds are among the worst performers in a local currency debt gauge, with some saying the pain is just beginning.

“We are starting to be wary of Asian bonds amid deteriorating inflation,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. “Even if domestic demand in the region continues to recover, the inflationary backdrop will prompt even the most reluctant central banks to tighten.”

Although it was a terrible year for local currency debt investors amid mounting global price pressures, Asian bonds suffered the brunt of the losses. Even a mini-bounce over the past month has largely circumvented the region: Central Asian stocks are the only group to lose money, while Asia-Pacific stocks lag their global counterparts. America and Africa, according to data from a Bloomberg index. Only conflict-ridden Eastern European debt has performed less well, and a recent flurry of inflation data that surprised on the upside is expected to aggravate Asia’s underperformance.

Countries considered late in entering the rate hike cycle are punished.

India’s decision in February not to raise borrowing costs on a bet that inflation will slow proved short-lived and the country was forced to opt for a 90 basis point tightening. Its shorter-term yields show investors’ impatience with the pace, jumping a percentage point since the start of May. Similar yields in Thailand climbed 70 basis points over the same period as the country has not raised rates since 2018.

Global institutional investors, who had been bullish on Asia late last year amid expectations of renewed growth, are becoming skeptical. The region’s fixed income market earned a net sentiment score of 6% in HSBC’s June Emerging Markets Survey, compared to 31% for Latin America. Asia’s score is down from 16% in March.

Asia Pressure

Supply chain bottlenecks from lockdowns in China are exacerbating inflationary pressure in the region, as China is the largest trading partner for many Asian countries.

Inflation in Thailand accelerated to 7.1% in May, faster than the 5.9% gain forecast by the economist and the fastest since 2008. In Indonesia, consumer prices rose in fastest pace since 2017 in the same month, while South Korea’s inflation beat economists’ estimate. every month since January.

By contrast, there are early warning signs that inflation may be on the verge of plateauing in Brazil and Mexico.

“Inflation will peak last in Asia,” said Edwin Gutierrez, London-based head of emerging market sovereign debt at abrdn, which oversees about $677 billion.

This rise in inflation is prompting central banks in the region to act, joining their counterparts in Latin America and Eastern Europe in raising rates to combat price pressures.

India’s central bank has finally signaled further rate hikes are coming after making a second consecutive hike last week, while at least two more moves are being considered in the Philippines after policymakers hiked rates for the first time since May 2018. Malaysia also boosted borrowing costs for the first time in four years last month.

Read more: One-month bond rally faces threat of Indonesian rate hikes

Even Asian central banks that have yet to join the global tightening cycle are now under pressure. The Bank of Thailand has signaled an impending hike after inflation hit a 14-year high and the Bank of Indonesia is expected to hike rates in the coming months.

“Upward revisions to inflation forecasts in emerging markets in Asia are starting to catch up with the rest of emerging markets,” Goldman analysts led by Kamakshya Trivedi wrote in a June 8 report. “Given the more dovish posture on Asian emerging market curves, this has translated into persistent rate underperformance in recent months.”

Here are the top things to watch in emerging markets this week:

  • Central banks in Brazil and Taiwan expected to hike rates

  • Poland, Croatia, Russia and Argentina to release inflation data

  • Russia is expected to release preliminary GDP data for the first quarter. Data will highlight initial impact of sanctions after Ukraine invasion

(Updated bond yields in sixth paragraph.)

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Robert D. Coleman