The global outlook for developed countries’ government bonds nowadays is not particularly attractive in terms of returns. Coupons are low, equity markets are doing well and central banks are uncertain about whether to keep interest rates low or start raising them. Emerging markets could therefore represent a better opportunity for fixed income investors. Turkey and Brazil are especially alluring.
The Outlook for the US and the UK
As the Fed is expected to keep raising interest rates this year, the interest rate related risk for US bonds is going to drive prices down and yields up. Moreover, the flourishing US equity market that has been rallying since the 2016 elections is pulling money out of fixed income. Nonetheless, the recent slowdown in US stocks due to presidential controversy reminds one of the risk-managing purposes of Treasury Bills.
The Bank of England has a targeted inflation of 2% before starting to raise interest rates. Despite their latest decision to keep the interest rate at 25 basis points, CPI has risen above this target to 2.3% both in February and March. It then had a significant rise to 2.7% in April. This trend is unlikely to change in the months to come and we can expect interest rate regulation to be implemented.
The Outlook for the EU and Japan
Unlike the UK, inflation in the European Union hasn’t reached the 2% target that should trigger European Central Bank interest rate rising policy. Except for February’s inflation rate of 2% that was related to volatile elements in the inflation calculation such as energy and food. In the short term, interest rates will most certainly remain negative.
Japan has a very comparable situation. A 2% inflation target is yet to be reached before the nation will start raising interest rates. In the long term, the EU is showing signs of growth and confidence in markets with a PMI of 56.7 beating expectations. Japan has been growing for the past five quarters and its economy expanded 2.2% during the first quarter. With this data, a negative interest rate recession policy is not going to be suitable any longer. Interest rates rises are to be expected.
Brazil: the Negative Correlation
Recent corruption issues with Brazil’s president Temer could be a reason not to buy Brazilian bonds. Nonetheless, as he told the Brazilian newspaper “Folha de S.Paulo”, Mr.Temer doesn’t seem willing to step down. Anyhow, since 2014, Brazil have been going through a recession and had to deal with very high inflation rates going from 6% in 2014 to almost 11% at its peak in 2016.
Since August 2016, the inflation rate has been decreasing month after month to 4% and Brazil’s high-interest rate policy implemented to fight this inflation can now come to an end. Interest rates have already been slashed from 14.25% to 11.25% since October 2016.
They are expected to keep decreasing, driving bond prices up and generating a negative correlation with developed countries’ bonds whose prices are expected to go down. The double advantage here is to get high coupons with a risk that can be managed with developed countries’ bonds.
Turkey: the Credit Rating Upgrade
President Erdogan’s economic policies have managed to stabilise the Turkish economy. Since his election as prime minister in 2003, inflation has decreased to stabilise between 8-12% against an average of approximately 70% (though sources vary) during the 1990s. The country’s debt has been strongly growing to 800bn lyre but the debt-to-GDP ratio is down to 30% in 2016 from 65% in 2003.
The global policies that led such changes were strengthening the private sector, the independence of the central bank and easing government regulations. The recent coup against him ended up strengthening his political position because both his supporters and opponents denounced the attempt.
Credit rating agencies may now view Erdogan and his economic acumen with less scepticism. Statements from a Fitch executive testified that credit rating agencies may have a positive look on Turkey. An upgrade in credit rating would consequently cause Turkish bond prices to rocket.
Despite these elements, however, developed market fixed income have the advantage of strongly managing risk through intrinsic minimal risk and negative correlation with stock markets while emerging countries have many unstable factors to be monitored, such as currency fluctuations. Nonetheless, the global outlook shows that it is worth digging into emerging markets for fixed income opportunities.