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Investors prepare for rate shift 0

Jun 18, 2013

The recent rise in US Treasury bonds has jolted Latin American borrowers – along with the rest of the issuing community that uses treasuries as a pricing benchmark – out of an easy period of cheap funding, and put many LatAm bond deals on hold.  

As investors globally study the uneasy economic recovery in the United States, and the US Federal Reserve’s likely reaction to it, investors are nervously positioning in a bid to play the rate change profitably. Already cash is thundering out of emerging markets.

"It’s a major shift," said Jim Barrineau, portfolio manager at Schroders. "The provision of liquidity by the Fed has been unprecedented and long lasting. To reverse that, even if it’s going to be a multi-year process, is going to create volatility. Without trying to predict specific levels, it seems obvious this is going to be a long process."

He notes he has reduced exposure to corproates in dollars. "If you start with the sovereign picture, every 10 year and over bond is going to be affected by the treasury sell-off. Rates have to reset across the entire spectrum. Sovereign debt is in the process of being hit, corporate debt will reprice relative to sovereign debt."

Société Générale believes US 10-year yields could rise as high as 2.75% at the end of 2013 – from 2.18% in early June.

"That means the correction is only just starting," said Benoît Anne, head of EM strategy at the French bank, which expects US quantitative easing to begin tapering off in September.  

"We’re waiting for what we call the real money capitulation, when long term investors will start to offload their EM bond position, he said. "That might have started, but really it’s not over."

Despite the uncertainty, the world’s largest bond fund is relaxed about the possibility that the Fed will abruptly hike rates.

"If US interest rates were to rise significantly, virtually all dollar issuers whether sovereign or corporate would be affected," said Ignacio Sosa, EVP, for emerging markets product management at Pimco.

"This is especially true of issuers whose local markets are not developed enough to serve as an alternate source of funding," Sosa said. "Nevertheless, Pimco does not believe that US rates are poised to dramatically accelerate higher in the near term."

Opportunities remain. Barrineau identified Brazil’s local market as a favorite, following recent adjustments to the IOF picture. Flows have gone both ways in the wake of the decision, but the net result should be positive. 

"There’ll be some back and forth there. But if the currency is going to be more stable, the absolute levels are also pretty attractive," he said.

For a full discussion of the changing interest rate environment, see the July edition of LatinFinance, online from June 28.

LF



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“The crisis has been a setback for reserve diversification."

Jan Dehn, Ashmore Investment Management