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Bond Funds Cheer Emerging Markets Moving Fast to Choke Inflation

(Bloomberg) — Global bond investors are on the prowl for emerging markets that are ahead of the game on inflation.

TS Lombard recommends funds buy local debt from Brazil, where a third interest-rate hike is expected when officials meet Wednesday. PineBridge Investments praised inflation tough talk from Bank of Russia Governor Elvira Nabiullina and predicted gains for the nation’s longer-maturity bonds.

Central bankers in the developing world are treading a fine line managing price pressures in places where the scars of hyperinflation are fresh and also nurturing economies still struggling with the coronavirus pandemic.

While the pattern is far from consistent, climbing commodity prices and undervalued exchange rates are turning up the heat across the board, with attention this week shifting to inflation data in Argentina, India and Poland.

“Investors will ultimately favor those countries in which central banks are able to get ahead of inflation,” said Jon Harrison, the London-based managing director for emerging-market macro strategy at TS Lombard. “It’s essential that central banks react pro-actively.”

So far, Brazil and Russia stand out, he said.

Central bank chief Roberto Campos Neto has said he’s willing to do whatever is needed to keep Brazil’s inflation within target, and economists are unanimous in predicting another hike this week for Latin America’s largest economy.

The nation’s bonds have returned about 10% since the first rate increase in March, while the currency has appreciated 9.2% to lead emerging-market gains during that span. In contrast, a gauge of developing-nation local-currency debt has increased less than 1% this year.

Loomis Sayles & Co. is another fan of Brazilian bonds and says further currency strength should help contain the pace of price growth.

“Appreciation limits the number of hikes as it lessens the risk of pass-through inflation,” said Edgardo Sternberg, co-manager for emerging-market debt portfolios in Boston at Loomis Sayles, which oversees $346 billion. The firm favors the shorter-end of the yield curve and prefers not to hedge against the dollar, he said.

Elsewhere, hawkish comments from Russia’s central bank chief will probably support the ruble, which may help to stabilize inflation expectations, said Anders Faergemann, a money manager at PineBridge Investments in London.

A fourth rate hike is “very likely” in July, Nabiullina told an online briefing Friday after lifting the key rate by a half percentage point.

Unanchoring Risk

At the other end of the spectrum, investors are shunning markets where policy makers are letting price pressures escalate. Poland and Hungary, where bond returns are more modest, have prompted particular caution.

“We are cautious in the lower-yielding markets with high correlation to core rates and where risks of inflation becoming ‘un-anchored’ are most concerning,” said Mary-Therese Barton, head of emerging-market debt in London at Pictet Asset Management Ltd.

Hungary’s annual consumer price index climbed to 5.1% in both April and May, the highest since 2012 and the fastest pace in the European Union, while the level in Poland has escalated to 4.8%, the quickest in a decade.

The headline consumer-price index is also above target in countries including Turkey, Mexico, India, the Philippines and South Korea, HSBC Holdings Plc said in a research note this month.

Regardless of central bank efforts to contain inflation, any external inflation shock emanating from the U.S. would stymie even the most aggressive stance.

A quick rise in U.S. rates “can have negative repercussions,” said Michel Vernier, head of fixed income at Barclays Private Bank in London. “We have seen this during the 2013 taper tantrum when rates spikes at the U.S. long end caused major emerging-market outflows.”

Hike or Hold

Bank Indonesia’s rate decision will be in focus on Thursday as traders see how the central bank balances its twin objectives of currency stability and supporting growth. Policy makers are expected to keep the seven-day reverse repurchase rate steady at 3.5%

The central bank has cut the policy rate by 150 basis points since the pandemic last yearBrazil’s central bank is set to meet on Wednesday, likely following through on its plans to raise the Selic rate to its pre-pandemic level. The real was Latin America’s worst-performing currency last weekA reading of Brazil’s economic activity index for April on Monday will likely reflect a pickup amid emergency cash handouts and relaxed restrictionsTurkey’s central bank will likely keep its benchmark rate unchanged for a third month at 19% on ThursdayWhile the economic case for a rate cut is weak, with inflation set to rise again and the currency vulnerable, the central bank “may adjust the language of its statement to lay the ground for a possible easing later in the summer,” Bloomberg Economics said in a reportGovernor Sahap Kavcioglu has sought to assuage concerns of premature easing after President Recep Tayyip Erdogan renewed his calls for lower borrowing, giving a vague reference to summer months as a target dateUkraine’s central bank may raise its benchmark rate by 50 basis points to 8% the same day after inflation jumped to a two-year highThe hryvnia, one of the region’s best-performing currencies this year, may help to relieve price pressure in the coming monthsPolicy makers in Egypt will also probably leave the key rate unchanged on Thursday

Biden Talks

On Monday, President Joe Biden will meet Turkey’s Erdogan in Brussels, where their talks will focus on military matters, as NATO allies hold a summitBiden will also meet Russian President Vladimir Putin in Geneva on Wednesday — their first direct encounter since Biden took office in January. The summit is expected to be tense, as Washington and Moscow are at odds over a range of issues, including cybersecurity, Ukraine and the Kremlin’s persecution of Putin’s political opponents

What Else to Watch

The People’s Bank of China is likely to refrain from boosting fund injections as 200 billion yuan ($31 billion) of one-year policy loans come due Tuesday. Eight out of 10 traders and analysts surveyed by Bloomberg expect a cash rollover without pumping in extra fundsThis signal from the central bank will come as liquidity in the banking system is expected to tighten this month with local governments set to sell more debt and banks hoarding cash for quarter-end regulatory checksChina will announce data on Wednesday that is likely to show that the economy continued to gain momentum in May. Industrial production growth likely held firm, although retail sales probably rose at a slower pace than the previous month, according to analysts’ estimatesOn Monday, India is forecast to announce that May consumer-price inflation quickened to 5.4%, according to the median estimate of economists surveyed by Bloomberg. While that’s above the central bank’s 4% mid-point target, it probably won’t prompt a hawkish response as policy makers are focused on supporting the economic recovery, according to Bloomberg EconomicsIndonesia and India will post trade figures for May on TuesdayPoland’s CPI data will be in focus after the head of the country’s central bank snuffed out any final doubts about his pledge to maintain record-low interest rates, hammering home the message that price pressure is temporaryThe zloty posted its first weekly decline since April against the euro in the five days through FridayInvestors will monitor El Salvador’s bonds after the nation became the world’s first to formally make Bitcoin a legal tenderColombian retail sales data for April, scheduled for Tuesday, will probably show a large jump from a year earlier, according to Bloomberg Economics. April industrial production numbers on the same day will also likely flag an annual riseOn Friday, investors will watch a reading of April economic activity for a large advance from a year earlierPeru is slated to release a reading of its April economic activity index on Tuesday, which Bloomberg Economics expects to show a jump of 60.3% from a year earlierTraders will watch Argentina’s May CPI data on Wednesday for signs that inflation stayed high

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