HSBC Sees Pain Giving Way to Gains in Emerging Bonds in 2016by
Bank upgrades stances on Malaysia and Brazil securities
Global investors lost money on developing-nation debt in 2015
Global funds’ appetite for emerging-market bonds is seen rebounding in 2016 after currency losses outweighed returns on the securities this year, according to HSBC Holdings Plc.
“The universal pain suffered in 2015 will give way to selective gains in 2016,” analysts led by Hong Kong-based Andre de Silva wrote in a report Thursday. “Growth in emerging-market countries is unlikely to bounce back vigorously next year but should be less gloomy than in 2015. The inflation trajectory is also likely to be benign in 2016.”
Europe’s biggest bank says it’s bullish on local-currency sovereign debt in China, India, Mexico and Turkey and counts bonds in Brazil and Indonesia among its best bets for the coming year. In addition, HSBC said it’s shifted to a neutral stance on Malaysian notes having previously been bearish. Domestic emerging-market securities lost 1.3 percent in dollar terms so far in 2015, after falling 0.4 percent over the previous two years, a Bloomberg index shows. Hong Kong’s dollar, which is pegged, is the only one of 24 emerging-market currencies to have not weakened versus the greenback this year.
HSBC joins Goldman Sachs Group Inc. and Bank of America Corp. in calling an end to an emerging-markets sell-off spurred by a deepening China slowdown and the prospect of the first U.S. interest-rate increase in nearly a decade. Gauges of bonds, currencies and shares in developing nations have all advanced since September, rebounding from their biggest quarterly losses in four years.
Brazil’s 10-year bond yields are 350 basis points higher than “fair value," while those in Indonesia and Turkey are at least 100 basis points above where they should be, HSBC estimates. The nations’ respective yields of 15.50 percent, 8.50 percent and 9.89 percent compare with 2.23 percent for similar-maturity U.S. Treasuries.
While emerging-market currencies are seen weakening in 2016, depreciation is expected to be more gradual than this year, HSBC said. A Bloomberg index tracking their performance against the greenback has lost 13 percent so far in 2015, set for the biggest annual loss since 2008.
“There are currently fewer across-the-board fear factors,” HSBC said in its report. “The Fed’s hike cycle will probably be gradual, a 1990s style currency crisis is unlikely to be repeated, and exchange rate tensions are easing.”
HSBC sees the tide turning for emerging markets, where it estimates outflows from government debt reached $40 billion last quarter, wiping out the investments recorded in the first six months of 2015. In reports issued last week, Bank of America’s strategists said they are “constructive” on emerging-market currencies in the “medium term,” while Goldman Sachs forecast that developing economies will grow 4.9 percent next year, up from an estimated 4.4 percent in 2015, the first acceleration since 2010.
East Asian bonds are better prepared to deal with the effects of an increase in U.S. borrowing costs as investors may have already gradually reallocated their funds, according to a report from the Asian Development Bank. Slowing economic growth however could lead to debt rating downgrades as government finances weaken and corporate profits decline, the Manila-based lender said. East Asia includes China, Hong Kong, Indonesia, South Korea, Malaysia, Philippines, Singapore, Thailand and Vietnam.
The Bloomberg Emerging Market Local Sovereign Index of bonds has climbed 2 percent in the past two months while the MSCI Emerging Markets Index of shares has risen 6.3 percent.
HSBC’s top trade ideas for 2016 include buying five-year Brazilian debt, on a currency-hedged basis, and buying Indonesia’s 10-year notes. It also recommends receiving non-deliverable interest-rate swaps in Malaysia and India.
The biggest shifts in HSBC’s stance are in Brazilian and Malaysian bonds, where it believes most of the negative news has been priced in. The lender is “mildly bullish” on Latin America’s biggest economy where it finds valuations attractive despite the current political and fiscal uncertainty, according to the report. For its upgrade on Malaysia, the lender cited the government’s fiscal prudence while adding that investors have taken into account most of the negative domestic political news.
HSBC also advised receiving five-year non-deliverable interest-rate swaps in China, where it sees the prospect of further monetary easing. The nation’s seven-day repurchase rate is forecast to decline to 1.75 percent in 2016, from 2.32 percent currently.
“Lower growth, slower rate of job creation, and further deflation suggest that much more monetary easing is essential,” HSBC analysts wrote in their report. The yuan’s likely inclusion in the Special Drawing Rights basket “should trigger increased inflows from foreign central banks into the bond market over the next few years,” they wrote.