Investors flock back to local currency paper, but QE risks hover

Investors flock back to local currency paper, but QE risks hover

Despite local currency debt suffering from a repricing of emerging market risk earlier this year, investors are piling back in — and the market could be headed for another sharp adjustment, say some.

A surge of interest in Latin American local currency at the beginning of the year abruptly reversed in May when US Federal Reserve head Ben Bernanke raised the possibility of ending quantitative easing. Some local currency instruments were repriced, although now that is reversing as investors spot a buying opportunity.

“Since September, investors have moved back into EM bonds and currencies, following the delay in the tapering,” says Gordian Kemen, head of LatAm fixed income research at HSBC. “There may be a new layer of froth forming that can be taken out, of people that are using what could be a short term window for risk-taking.”

Edwin Gutierrez, portfolio manager at Aberdeen Asset Management, which manages $312 billion, says that although the sell-off provided an opportunity to recalibrate a portfolio that may have been light on local currency debt, the extent of the renewed enthusiasm is worrying.

“I’m always afraid when you get this coalescence around one view,” he says. “It’s rally on. Guys are in position for it, guys are chasing the market. That’s the consensus view — so that’s what concerns me.”

Others are more bullish on the asset class.

Carlos García Moreno, chief financial officer at América Móvil, says he expects to be able to reopen the firm’s global-local instruments known as títulos de crédito extranjero before year-end — and that an extraordinary series of events in the market should not be taken as an indication of the longer term outlook.

“These are not regular events,” he says. “They were quite exceptional.”

“Rates in April were at 1.6% to 1.7% — they went to nearly 3% when the market was expecting the news of the tapering. A significant part of the adjustment has already taken place with a doubling of the long term rates.”

Jan Dehn, head of research at Ashmore Investment Management, has a similar view.

The ferocity of the selloff in May and June, Dehn says, was the result of a “technical overhang” caused by hedge funds that got caught out on a giant bet that Japanese investors would pour into emerging market debt following the Bank of Japan’s pledge in March to do “whatever it takes”— including doubling the money supply — to fight deflation.

They got it wrong, Dehn says, and with Japanese accounts still on the sidelines when taper talk began — and thereafter yet more bearish following a slump in the Nikkei index — the stampede of hedge fund money out of the asset class triggered a massive technical rebalancing in the market.

“The entire premise of that speculative money going into emerging markets in April, the entire premise for that speculative trade is gone,” he says. “You’re not going to see a huge sell-off in EM assets.” LF

For more on the local currency investment outlook, see the November/December edition of LatinFinance.