Government reforms are delivering the biggest returns in EM bond markets

(Bloomberg) — Bond investors are signaling that good government matters more than financial coverage in emerging markets.

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Since the beginning of April, investors have begun to more aggressively sell bonds from high-yield countries where governments have eased fiscal policies. As long as international locations are emphasizing fiscal vigilance, they are willing to buy debt with low or even adverse yields.

This is visible in the performance pattern of the second quarter. The top performers – including Argentina, Turkey and Egypt – are all pursuing financial reforms. At the opposite end of the scale are countries with rising deficits, such as Mexico and Brazil.

“Fiscal dynamics are moving to the center of investors’ radar,” said Adrien du Toit, director of emerging markets credit score analysis at AllianceBernstein. “This is partly due to the surprise election results and the fact that politics and fiscal dynamics are intertwined. It could also mean that monetary easing may not be as deep or helpful if the higher-up has a longer-term effect.

For the two years through March, emerging market bond investors were chasing higher yields, and countries with the most aggressive central banks delivered the most productive returns.

Mexico outperformed local-bond traders by 37% over this era, Brazil returned 22% per year, Poland and Colombia returned 18%. The worst performers, including Turkey, Argentina and South Africa, were penalized because their fiscal policies were deemed too poor.

Since then, a resurgence of foreign currency volatility has prompted cash managers to change their stance. The prospect premium was once again seen as noteworthy as the path to hikes opened up, with the spread on dollar-denominated government debt over Treasuries posting the biggest quarterly jump since 2022.

Now, governments that are making possible alternatives to poor fiscal policy are being rewarded the most.

Argentina, for example, is the leading local-currency bond performer for the quarter through June, after incoming President Javier Meili overcame setbacks to gain approval for tax measures that would help the country meet fiscal targets and control runaway inflation. Can help in doing.

Similarly, Egyptian bonds are taking good advantage of President Abdel-Fattah el-Sisi’s push for financial reform. Buyers are also rewarding Turkey for returning to fiscal conservatism.

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“This focus on fiscal reforms is certainly present in emerging markets,” said Yvette Babb, portfolio manager at William Blair Funding Control. “In our view market participants are likely to continue to focus on the credibility of macro-economic policies.”

Brazil has slashed bond deficits and incoming Finance Minister Fernando Haddad has announced spending cuts to shore up the country’s budget. The country’s debt performance was the worst among emerging markets in the last quarter.

Indonesian bonds also rose after reports that the incoming leadership would raise debt levels, although it has since backed off. Elsewhere, Nigerian bonds fell after incoming President Bola Tinubu’s government did not pursue fiscal entry transition fee reforms.

“Investors will expect to see both fiscal restraint and monetary tightening,” said Joseph Cuthbertson, independent emerging markets analyst at PineBridge Investments.

However, recent weeks of riots in Kenya have shown how difficult the implementation of fiscal reforms can be, with at least 41 people killed in protests against proposed tax increases led by President William Ruto. The federal government has since begun additional borrowing to make amends for abandoning its tax plan.

“The problem with fiscal reforms is that they are increasing the pain for populations that are already suffering,” said Charles Robertson, head of macro-strategy at FIM Companions. “Kenya’s protests indicate that there are limits to how fast these fiscal reforms can proceed. “This is the main uncertainty that investors have to grapple with.”

AllianceBernstein’s Du Toit said the eventual start of fiscal easing by the U.S. Fed would help keep global borrowing rates low, with emerging markets wanting to be able to stabilize debt without derailing economic growth.

“It is important for governments not to over-promise and under-deliver as the negative market reaction could be quite strong,” said Nathalie Marshik, independent emerging markets outlook analyst at HSBC.

What to keep an eye on:

• China, Republic of India, Egypt, Hungary, Czech Republic, Brazil, Mexico and Argentina will post their actual inflation information, which could signal to investors a day of financial easing in those international locations.

• Peru’s central bank is expected to keep its benchmark rate at 5.75% for the second consecutive meeting on July 11.

• China will file its business data on Friday, revealing the impact of its stimulus on the external economy

• Türkiye will file its current account balance on Friday; President Recep Tayyip Erdogan has said that the deficit will be reduced to about 2% of GDP in this period.

–With assistance from Marcus Wong.

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