HSBC feels emerging market bonds worth a look as bull run in US dollar seen over

It may be time to look at emerging market bonds as the bull run in the US dollar and a stiffening in US bond yields may have run its course, research reports by global lender HSBC said.

“Contrary to market consensus, HSBC believes the US dollar rally has ended and the US Treasury curve has steepened sufficiently. Combined, this suggests investors should begin to be bullish on high-yielding local emerging markets,” according to a report written by analysts led by Paul Mackel, head of global EM FX research of HSBC.

Mackel said emerging forex markets in the first half of this year were held hostage to broad US dollar strength and the steepening of core bond yields. He believes investment opportunities have arisen following the sharp sell-off in emerging forex and local bonds.

“Currency volatility can deter investors in local bonds. However, once volatility peaks, this can offer a good point to enter with yields likely to fall alongside volatility. Given a sizeable FX risk premium, this could be significant for some emerging market local bonds – notably Indonesia and Brazil,” Mackel said.

While bond investors would focus on global factors, he said investors should in fact pay more attention to the local political and economic factors of each of these markets which are playing an important role in the emerging bonds and currency markets.

“In India and China, domestic developments are positive and there is scope for additional easing,” Mackel said. “With Brazil, elevated implied forex volatility might be close to peaking and, in turn, hedging costs, but local factors dictate a neutral stance. Therefore, our bullish stance on these bond markets.”

“We do not like South African bonds or the country’s currency, in part because of elevated inflation. We are also cautious on local currency bonds in Turkey because of the uncertain political backdrop,” Mackel said.