Emerging Market Bond Sell-off Overdone says Old Mutual

Turkey and Argentina may be in trouble, but the contagion slump has gone too far says Old Mutual's Delphine Arrighi

Emma Wall 6 September, 2018 | 11:38AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You". I'm Emma Wall, and I'm joined today by Old Mutual's Delphine Arrighi to talk about emerging market bonds.

Hi, Delphine.

Delphine Arrighi: Good morning.

Wall: So, emerging markets have been in the news a lot recently and not always for the right reasons, especially emerging market debt, which is an area which is influenced by currencies. I thought perhaps we take them one-by-one; Turkey and Argentina because they're drawing the most headlines. What are your thoughts and concerns around Turkish currency?

Arrighi: Well, Turkey has indeed been under a lot of pressure, deserved in our view. The Central Bank there has been reluctantly hiking rates. They've always been coming, responding to inflationary pressures and to some extent market pressures, a little bit too late and too little in the magnitude of the rate hikes that they've been delivering. Obviously, they are running a very large current account deficit. The fiscal loosening that we've seen in the last couple of years have also fueled some of that current account deficit and really their inability to deliver those hikes have sort of put the pressure on the currency. With think the latest development and in particular the rise in inflation print is finally pushing the Central Bank to address again those issues. And we have hopes that at the next meeting at September, they will finally deliver a hike that is enough to meet market expectations.

Wall: Now jumping across the globe, before we bring the two together, what are your thoughts on Argentina?

Arrighi: Well, Argentina is probably a trickier case. Again, they've also had a large current account deficit, but obviously they've been struggling with a lot of imbalances inherited from the previous administration. The government is being trying to juggle restoring growth, capital spending, and at the same time, reigning in the fiscal deficit. This has all gone a bit beyond their expectations. They lost the battle against inflation and they've seen a lot of capital outflows resulting from that, not only from the offshore investors community, but also from the locals, who also have lost confidence in the economic outlook.

We think the measures that the government has announced lately and fast-tracking the fiscal consolidation are all the right measures and all are going in the right direction. Obviously, the guarantee from the IMF program is also – should help restore confidence. It hasn’t been the case yet. The market is still sort of hesitating as to whether Argentina will make it next year. And we think the market fears are a bit overdone at those levels.

We think we will continue to see some pressure on the currency in the very near-term as the central bank continues to unwind that stock of laybacks, as we call it, there is short-term Treasury bills that they have issuing against the stabilization of portfolio inflows in the past. So, as long as they continue to unwind that stock of laybacks, some of it is not being rolled over into new debt. And that releases liquidity in the system, which in turn finds its way to the dollar market.

So, we might continue to see a bit more pressure in the very near-term. But eventually, given the extent or the magnitude of the correction in the currency that has lost more than 100% year-to-date, policy rate now is 60%. We will see a very strong adjustment in the current accounts, probably to balance account next year. So, that will reduce some of the pressure. And at the same time, I think we are coming to a level where even the locals will start to see less of a need to push for further dollarization here.

Wall: Now, of course, as an active fund manager, across emerging markets, you don’t have to invest in those markets if you see the risks is too high, but the logical question is how much contagion risk is there among these Eastern Europe and Latin American countries. Because you get to a point where these things can't be contained, and it does start to affect the asset class as a whole.

Arrighi: Well, we think that the contagion that we've seen lately is a bit overdone. Again, a lot of that is also linked to the external environment that has become a lot more challenging for EM. We've had a rise in the federal rate hike expectations, the unwinding of QE that is all adding to a tightening of global liquidity conditions. And on top of that, we have a lot of uncertainty when it comes to an escalation of a potential trade war between the US and China, and there are a lot of negative news in terms of geopolitical pressure coming from the US on to those very different countries, Russia, Turkey, you name it.

So, within the environment really has precipitated that contagion, but we think at this stage it is a bit overdone. When it reaches countries like Indonesia and the rupiah that is now trading at weaker levels than back at the '97 Asian crisis. Indonesia is in a much better place nowadays. They do have a current account deficit, but it’s a relatively small one, even compared to the levels during the Taper Tantrum crisis. And the Central Bank has been very proactive in trying to insulate the market from global turmoil. So, we welcome all those pre-emptive rate hikes that they've been delivering. Initiatives from the government to try to reign in the current account deficit by reigning in capital imports. And we think ultimately, that will be recognised by the market.

Wall: Delphine, thank you very much.

Arrighi: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.


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Emma Wall  is former Senior International Editor for Morningstar