A great era for emerging-market bonds may be only just beginning, according to a study of break-even rates.
After the securities narrowing their yield spread over Group-of-Seven debt by 100 basis points since a 2018 peak, a long-term disinflationary backdrop should see that theme persist for many years to come. Projected inflation for a cross-section of developing nations will average 4.74% from 2026 to 2031, versus an average 5.25% over the past five years, according to the analysis.
“The disinflationary outlook offers a potential capital gain and a stable high income from emerging-market debt,” said Akira Takei, a global fixed-income money manager in Tokyo at Asset Management One Co., which oversees the equivalent of about $510 billion. “The pandemic has yet to subside, so global economies overall see muted inflationary pressure.”
Inflation is a critical component for bond returns, as shown by the slide in global government debt in January as the Biden administration announced it would roll out $1.9 trillion of additional US stimulus. Treasuries have paced the declines, creating the possibility that regions with more subdued price pressures will entice additional inflows.
Local-currency emerging-market debt has dropped 0.4% last month, less than a third of the loss that its G-7 peers incurred.
The US five-year forward five-year inflation swap, which measures expectations for future inflation in the world’s biggest economy, climbed to 2.45% this week from as low as 0.97% during the initial coronavirus selloff in March. The most recent actual consumer-price index reading was 1.4% for December. January data are due next week.
{{/usCountry}}The US five-year forward five-year inflation swap, which measures expectations for future inflation in the world’s biggest economy, climbed to 2.45% this week from as low as 0.97% during the initial coronavirus selloff in March. The most recent actual consumer-price index reading was 1.4% for December. January data are due next week.
{{/usCountry}}Inflation may also be damped down in developing nations by the expected slower rollout of vaccine distribution, which will increase the prospect that the pandemic will cause long-lasting damage to some of those countries.
“I see the pandemic as reducing emerging economies’ overall growth potential,” said Kota Hirayama, senior emerging-market economist at SMBC Nikko Securities Inc. in Tokyo. “Inflation may eventually settle at historically low levels in these economies.”
Methodology
Forward break-even rates were derived from five- and 10-year inflation-linked government bonds issued by seven developing nations, except for Mexico where five- and eight-year notes were used. The countries were selected based on being constituents of the Bloomberg Barclays Emerging-Market Local-Currency Government Index. The average was weighted by each country’s nominal gross domestic product.