BlackRock Says Local Bonds Sweetest Spot in Emerging Markets

  • Biggest rally since at least 2003 has further to run
  • Money manager likes Brazil, Indonesia as rate cuts likely

Looking for a way to get even more out of the rally in emerging markets? The world’s biggest money manager is betting on local-currency bonds.

BlackRock Inc., which oversees $4.6 trillion in assets worldwide, said the prospect of central bank rate cuts in countries like Brazil and Indonesia will help extend the biggest surge in the debt in at least 13 years. London-based rival Schroders Plc is also recommending buying emerging local bonds, anticipating they will be the best-performing asset class this year.

Economists expect central banks from Turkey to Russia to reduce borrowing costs in coming months as exchange rates stabilize, alleviating inflationary pressures, after a rout that drove currencies such as the ruble and real down more than 20 percent against the dollar in 2015. Local emerging-market bonds yield 6.37 percent on average, 63 basis points more than developing-nation dollar bonds, according to JPMorgan Chase & Co. indexes.

"We are in a sweet spot for emerging-market assets," Richard Turnill, global chief investment strategist at BlackRock, said in a research note on Tuesday. “We generally favor emerging-market local-currency debt over U.S. dollar debt. EM central bank rate cuts amid lower inflation should support many local rates markets.”

BlackRock’s bullish stance on local debt contrasts with a broader neutral call on developing-nation bonds and underweight position on global fixed-income. The money manager in February accurately predicted a turnaround in emerging markets.

Brazil, Indonesia

Turnill identified Brazil and Indonesia as the most attractive domestic bond markets. The Latin American nation will lower interest rates to 13.45 percent by the end of 2016 from 14.25 percent, according to the median forecast from 19 economists surveyed by Bloomberg. Indonesia’s benchmark is set to fall to 6.65 percent from 7.5 percent, a separate poll of 27 analysts showed.

Russia and Turkey also have the flexibility to lower lending rates this year, making local bonds attractive, according to James Barrineau, a New York-based money manager at Schroder Investment Management. Ten-year notes of both countries yield more than 9 percent, compared with 1.93 percent for equivalent U.S. Treasuries and minus 0.10 percent for Japanese debt.

“Local-currency will probably be the best-performing asset class this year,” said Barrineau, who helps oversee about $89 billion in fixed-income assets. “We’re in an environment where sentiment lifts all boats and it’s just a question of to what degree one outperforms the other.”

‘Virtuous Cycle’

Emerging-market local bonds have handed investors returns of 6.2 percent this year, according to JPMorgan indexes, the most in the period since at least 2003, the earliest year when data is available.

Speaking at a media briefing in New York on Tuesday after the note was published, BlackRock money manager Pablo Goldberg said developing nations are in the midst of a “virtuous cycle” as China’s economy stabilizes and currencies rebound.

While BlackRock has taken "a little bit of risk off the table," Goldberg still sees value in high-yielding currencies like the Mexican peso and Malaysian ringgit. He also favors quasi-sovereign dollar debt that suffered during an oil-price slump, including Petroleos Mexicanos and Kazakh Eurobonds. Brent crude has recovered 64 percent since touching a 12-year low in January.

"We feel like higher oil prices will bring some healing there," said Goldberg, who prefers high-yield over investment-grade debt.

‘Right Signals’

The Argentine government “moved a lot faster than most of us had expected in terms of normalizing the relations with the markets,” and it has maintained “a relatively high level of approval with the population,” William Landers, a money manager and managing director for BlackRock, said at the media briefing in New York.

South America’s second-biggest economy attracted almost $70 billion in bids for its first international bond sale in 15 years last week, selling $6.5 billion of 10-year bonds to yield 7.5 percent, $2.75 billion of three-year bonds to yield 6.25 percent, $4.5 billion of five-year bonds.

By selling bonds with relative short maturities, the government sent a positive signal to investors, Goldberg said. Doing so suggests the government is confident that its policies can improve the economy, allowing it to borrow at lower costs in the future, he said.

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