(Bloomberg) It’s a matter of pure conjecture, but the coming week may well be the moment when investors see the beginning of an end to the largess that helped propel emerging markets to unprecedented highs.
Though few expect a sudden turn of events, Russia’s interest-rate decision and the release of Brazilian inflation data could help settle a question that’s burgeoning in the minds of investors. Namely, how will markets in the developing world behave when central bankers tighten the policy screws?
“Any sign of a change to tighter policies, for example in China, Brazil or Mexico, could lead to a broader correction of valuations across emerging-market debt,” said Zsolt Papp, a money manager at JPMorgan Asset Management in London. “For now, the expectation is that most emerging-market central banks will maintain accommodative monetary policies.”
Developing-nation dollar bonds had their biggest weekly advance this year in the five days through Friday after weaker-than-forecast U.S. jobs data bolstered the case for President Joe Biden’s $1.9 trillion relief package. An index of emerging-market equities clocked up its best week since November.
The gains were all the more impressive because they came as U.S. Treasury yields climbed to their highest since the early days of the pandemic, signaling a growing concern that the stimulus measures will act as an inflation trigger. A Bloomberg study conducted in January found developing-world currencies typically sell-off when yields jump and are especially vulnerable when they’re historically low.
For Lutz Roehmeyer, the chief investment officer at Capitulum Asset Management GmbH in Berlin, an increase in Treasury yields are a welcome indicator of recovery, which is of greater concern to investors.
“Rising U.S. yields are a good sign of the economic recovery from the Covid crisis,” he said. “The growth effect for emerging markets should be much more positive than the cost of higher interest rates.”
While Brazil’s inflation reading and Russia’s rate decision will be closely followed this week, there’s little pressure for most countries to tighten policy now. Average inflation in the developing economies sat at an all-time low in the fourth quarter.
Underscoring investor optimism, a measure of implied volatility for currencies fell on Friday to the lowest since July. An index of expected price swings in equities was at a seven-week low.
