'Bloodbath' in EM bonds; first outflow in nearly a year
Emerging market bonds suffered a sharp sell-off. This week was the first to show an outflow from EM-dedicated bond funds since June last year
The outflow from emerging market bond funds was $866 million in the week ending on May 29, with the 52-week average flows now standing at $866.2 million, sharply down from $1.35 billion in the previous week, according to data from UniCredit's EM bond fund flows weekly report.
"Outflows from hard-currency funds offset all local currency inflows," Dan Bucsa, an economist with UniCredit, told Emerging Markets. "It's because of the Fed and a general re-pricing of emerging markets debt."
Last week, Federal Reserve Chairman Ben Bernanke hinted at an earlier-than-expected end to quantitative easing, spooking markets. Bad data from China further accelerated a fall in stock markets, especially in Japan.
In emerging market bonds there was "an absolute bloodbath" this week, Benoit Anne, head of emerging markets strategy at Societe Generale, wrote in a weekly market note.
"Not only has the Fed induced the uncertainty of tampering down QE as soon as the June meeting, leading to a sharp sell-off in G7 yields, but in addition renewed foreign exchange volatility is filtering through negatively onto domestic rates," he said, noting that South Africa and Turkey have been hit particularly hard.
Anne believes that this signals "the return of a top-down market," reflecting the fact that global liquidity retrenchment is becoming a major driving force.
'SELL YOUR EM BONDS'
"Sell your emerging market bonds. At this point, we see no value in keeping a bullish view on EM duration," he wrote.
UniCredit's report shows yield curves shifting upwards in South Africa and Turkey and steepening in Hungary and Poland.
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The local rates that increased the most since April 30 were Turkey's, followed by Brazil, South Africa, Mexico, Russia, Hungary, the Czech Republic, Malaysia, Thailand, Poland, Chile, China and Taiwan, according to Societe Generale data.
Indian rates were almost flat in the period, while Israeli and Romanian rates actually fell, the data showed.
Bucsa said it was "very hard to say" whether outflows from emerging market debt would continue.
"Local bonds still pay very high yields, so they are attractive," he said. "On the other hand, if investors feel that the US Treasury yields would go higher, this is likely to continue."
The strong rally in emerging market debt earlier this year narrowed spreads versus developed markets, leaving EM bonds more exposed to upward adjustment in the yields of US Treasuries, he explained.
Julian Jessop, an economist at Capital Economics, argues that it is "too soon to call the turn in global bond yields."
While Jessop believes that "yields should of course rebound to more normal levels, eventually," they are more likely to fall than rise over the second half of the year.He noted that unemployment is still high and this is likely to keep short-term interest rates "ultra low," inflation expectations are "unlikely to take off" and other investors "might also simply step up to take the Fed's place," particularly if there is a sharp sell-off in equities or the eurozone crisis flares up again.
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