Asset classes

Why the outlook for rates is attractive in emerging markets

August 09, 2022

Patient investors are likely to be rewarded as we expect yields to rally—that is, decline—in emerging markets (EM). That’s the key finding of Higher inflation is creating an opportunity in emerging markets, an analysis produced by Vanguard Fixed Income Group’s (FIG) Nishan Pradhan, Liza Ermolenko, Zoe Odenwalder, Nick Eisinger, and Daniel Shaykevich.

Reasons for optimism

The authors cite two major reasons why they think the peak in EM inflation is near and why the resulting disinflation1 will create attractive buying opportunities.

Differences in goods and services consumption patterns have contributed to higher EM inflation.

Recent inflation in emerging markets has been more supply driven than in developed markets. This makes EM inflation more likely to fall when supply-side pressures abate.

In general, central banks in emerging markets have been proactively hiking.

And market prices anticipate a good deal of rates hikes over and above what central banks have delivered.

Some EMs have done more of the heavy lifting on interest rates than others

Hikes made in the last two years, and hikes priced in by the market for the next 12 months, both in basis points.

This chart shows the level of rate hikes priced in for various emerging markets countries as of August 2022. Russia is the only emerging markets country that has raised rates well below the one-year implied forward policy rate. The Czech Republic and Chile have raised rates roughly in line with the one-year implied forward policy rate. China, Thailand, Malaysia, India, South Africa, Mexico, South Korea, the Philippines, Colombia, Poland, Hungary, and Brazil have hiked rates above the one-year implied forward policy rate.

Notes: Data are as of August, 2022. Priced-in hikes reflect the difference between current policy rate and 1-year forward implied policy rate. A basis-point equals 1/100 of a perentage point.

Sources: Vanguard and Bloomberg.

While the authors do not attempt to pinpoint the peak in inflation, they believe that local emerging markets rates are starting to look attractive.

“We are excited to have a strong process in place to play long duration EM local rates when the trend decisively turns,” said Shaykevich, senior emerging markets portfolio manager in FIG. “We believe we are close to this point.” 

Learn more. Read Higher inflation is creating an opportunity in emerging markets. (5-page PDF)

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1 Disinflation is a reduction in the rate of inflation.

Notes:

All investing is subject to risk including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss.

Investments in bonds are subject to interest rate, credit, and inflation risk.

Investments in bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.

Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility.

All investing is subject to risk, including the possible loss of the money you invest.

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