The election of Donald Trump has “no doubt” been deeply felt in emerging market sovereign bonds and currencies. But don’t be quick to judge, an HSBC report says. The “Trump tantrum” voters threw is different from the “taper tantrum” that sent stocks, along with emerging market currencies, reeling in 2013. There are decided fundamental trends driving price action that investors would do well to recognize along with nuanced undercurrents that will meaningfully impact bond investors. The emerging market bond rally ValueWalk has been writing about may just be starting in certain sovereign regions.
Most vulnerable” sovereign bonds are in South Africa, Turkey, Malaysia and Mexico
When looking at sovereign credit opportunities around the world, there are areas of strength but also weakness.
The “most vulnerable,” according to HSBC’s global fixed income rates strategists, are investors with exposure to South Africa, Turkey, Malaysia and Mexico. In these countries, weak external balances, negative credit migration and index-related bond outflows are the top concerns of HSBC’s Head of Global Emerging Markets Rates Research André de Silva and his team.
“It doesn’t help that Mexico, South Africa and Turkey can’t show much on the policy reform front,” the research note opined.
In Mexico in particular, the additional risk of a trade war looms as Trump’s protectionist rhetoric was a key feature on the campaign trail. HSBC, for its part, notes with caution that “if they are implemented,” expressing a degree of doubt, Mexican currency and debt markets could be shaken. (In a thank you rally in Cincinnati last night Trump appeared to double down on his tough talk with Mexico.)
Sovereign bonds that are winners are those with room for yields to go lower
There are, of course, winning sovereign bonds where there are losers.
Two winners are Russia, with an 8.79% ten-year note yield, and India, which has a 6.3% ten-year yield. India is currently pursuing an aggressive policy to ban cash and go all digital with its currency. Russia has a generally low debt to GDP level. These are regions “where domestic policies and potential for deep rate cuts are very favorable to rising capital gains.” That said, the ten-year bond in India was considered “fairly valued,” according to the report.
Brazil, coming off a damaging political scandal following its systemically significant oil company, Petrobras, “closely follows” India and Russia on the basis of both domestic policies and the potential for deep rate cuts. The scandal-plagued country has an 11.98% ten-year note yield. “Local rates in reform-minded Brazil still have plenty of real yield cushion and also significant policy easing potential, so we continue to like our long 10yr bond position,” the report said.
Brazil has another investment tailwind: relative value attractiveness. The HSBC report like’s Brazil relative to bonds in the Philippines, Thailand, Korea and Hungary.
China is an interesting case study. There has been much talk about a Trump trade war with the world’s second largest economy, which could deeply impact bond and currency valuations. HSBC, for its part, isn’t much concerned, saying the fears of a trade war are “overblown” and noting that the nation’s ten-year note is “fairly valued.”
Two of HSBC’s previous favorite sovereign bond investments, the high-yielding markets in Indonesia and India, have hit analysts targets and are falling out of favor to various degrees. While not recommending eliminating exposure in these sovereigns, HSBC recommends pulling back duration from the ten-year to five-year term structure.
HSBC’s top emerging market trades, in order of importance, are: 1) Long India five-year note; 2) Long Russia five-year note; 3) Long Brazil ten-year note; 4) Long Indonesia five-year note; 5) Pay Mexico ten-year MXN TIIE SWAPs.
Mark Melin is an alternative investment practitioner and Editor at Opalesque.