Goldman Sees No Reason to Flee Emerging Markets on Fed Move

  • U.S. bank bought Eurobonds in October in hunt for higher yield
  • Extra yield remains attractive even after rally, Goldman says

Not all bond investors are ready to rush out of emerging markets once the Federal Reserve starts raising interest rates.

Goldman Sachs Group Inc. is staying put. While U.S. policy makers placed a possible December rate lift-off back on the agenda last week, the New York-based bank envisages no erosion in the appeal of investing in higher-yielding assets such as developing-nation euro bonds. The reason: Fed rates won’t rise fast enough to diminish the allure of emerging-market debt that offers almost 400 basis points more than Treasuries. That’s about half a percentage point more than the average premium since the Fed cut rates to near zero seven years ago.

Investors dumped developing-nation sovereign bonds in September amid concern a slowdown in China will curb global growth. That helped widen the extra yield on those securities to a four-year high, luring investors like Goldman who wagered monetary policy in the U.S. and Europe will be supportive for longer. The case for “yield chasing” will stay popular in the coming months, according to Yacov Arnopolin, a money manager who helps oversee about $36 billion of emerging-market debt at Goldman Sachs Asset Management.

“The case for looking for yield in emerging markets remains intact,” Arnopolin said on Oct. 30. “Spreads continue to look attractive to us, especially in the context of a persistent low-rate environment and lack of high-quality alternatives offering comparable yields.”

Arnopolin remains steadfast in his view even after emerging-market bonds rallied in October, posting the biggest monthly gain relative to Treasuries in more than three years. It was only a rebound from earlier pessimism which had run too far and doesn’t erode the cushion the bond yields provide over the prevailing low returns in the U.S., he said.

“The anti-emerging-market sentiment got to extremes in September,” Arnopolin said. “Some of the reduction in risk premium has to do with the wash-out of the overly bearish positioning.”

Emerging-market bonds rallied last month, narrowing the risk premium by 41 basis points, the most since June 2012, according to JPMorgan Chase & Co. indexes. On Tuesday, the premium slipped one basis point to 386.

Buying Opportunity

While a U.S. interest-rate increase could temporarily disrupt an emerging-market bond rally, “the ensuing volatility will be short-lived,” Gregory Saichin, the chief investment officer for emerging-market fixed income at Allianz Global Investors Europe GmbH, said. That’s because investors have cash they want to put to work and a lot of bad news is being factored into bond prices.

“Any rate hike will come somewhat diluted,” Saichin said in an e-mail Oct. 30. “Any disruption could be an opportunity to get invested if sovereign spreads retest the wides.”

The risk premium for emerging markets will probably remain at current levels after a rate increase and may even narrow 30 basis points if the liftoff is delayed for two quarters, Saichin said. The likelihood the central bank will act at its Dec. 15-16 meeting is hovering near 50 percent, up from 33 percent a month ago, futures contracts show.

Still, U.S. monetary policy is not the only factor that will determine the fate of developing-nation bonds, according to both Saichin and Arnopolin. Given that many emerging-markets are dependent on oil either as net exporters or importers, prices of crude will play a role. Festering political issues will also dictate investor appetite.

In Brazil, President Dilma Rousseff faces potential impeachment proceedings over allegations she doctored fiscal accounts. Russia, the world’s largest energy exporter, remains under international sanctions for its role in the Ukraine conflict.

“For a sustained emerging-market credit rally, we need to see stabilization -- and ideally some upside -- in oil prices,” Arnopolin said. Investors will also look for “the resolution of uncertainty around some stories currently on the front pages. Examples include the political gridlock in Brazil and the geopolitical situation involving Russia.”

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