The difference between fixed-rate bond yields and those indexed to consumer prices show investors expect Mexico’s inflation to average 3.26 per cent the next two years, near the slowest since May. A similar Polish measure fell to 2.09 per cent last month, the lowest since at least April. Emerging-market bonds gained five per cent in dollar terms during the three months through February 12, the most in a year, compared with 0.1 per cent for government securities worldwide, JPMorgan Chase & Co and Bank of America Corp indexes show.
“We see only moderate growth compared to recent years, and these solid but hardly effervescent economic conditions should keep inflation in check,” Alessandro Bee, an economist and fixed-income strategist in Zurich at Bank Sarasin & Cie AG, which oversees 99 billion Swiss francs ($108 billion), said in a phone interview on February 4. “That’s a really nice environment for local bond markets.”
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While investors see inflation in the biggest emerging markets such as China and Brazil rising, the tame outlook elsewhere will allow policy makers to focus on bolstering the weakest economic growth since 2009 through lower rates, according to Bank of America.
2010 reversal
The rate of inflation in developing markets will remain at 6.1 per cent in 2013, slowing from a four-year high of 7.2 per cent in 2011, the International Monetary Fund in Washington said last month.
India, Poland, Colombia and Hungary have cut borrowing costs this year, in part because consumer prices are under control. Traders anticipate looser monetary policy in South Korea, Poland, Colombia and Hungary, according to a Morgan Stanley model that tracks interest-rate swaps.
That’s a reversal from two years ago, when a 55 per cent jump in the Standard & Poor's GSCI index of 24 raw materials in 11 months through April 2011 pushed up consumer prices and led central banks from China to Brazil to raise borrowing costs.
Brazil boosted rates 3.75 percentage points to 12.5 per cent in 15 months through July 2011. China lifted its one-year lending rate five times in nine months starting October 2010.
Growth throttled
Those moves throttled emerging-market growth to 6.3 per cent in 2011 from 7.4 per cent the year before, and punished bond investors, with JPMorgan’s GBI-EM Global Diversified Index losing 4.9 per cent in dollar terms between mid-October 2010 and mid-January. That was worse than the loss of 3.6 per cent for government securities worldwide, according to the Bank of America Merrill Lynch Global Government Index.
In Mexico, central bank board members led by Governor Agustin Carstens unanimously decided to leave the benchmark interest rate at a record-low 4.5 per cent on January 18, and signaled this month that they may lower borrowing costs for the first time since 2009 as inflation moderates.
“If the outlook described is consolidated, a reduction in the benchmark overnight interbank interest rate may be advisable,” Mexico’s policymakers said in the minutes of the January meeting published on February 1.
Slower pace
Consumer prices in Mexico rose at a 3.25 per cent annualized rate in January, the slowest pace since October 2011, after falling within the central bank's target range of two per cent to four per cent in December for the first time since May.
The two-year breakeven rate in Mexico narrowed from a 16- month high of 4.54 percentage points in July, according to data compiled by Bloomberg. The rate averaged 4.04 percentage points since October 2006 when Bloomberg started compiling the data.
Peso-denominated bonds returned 4.5 per cent in January, the most since June, Bank of America indexes show. The 21 per cent gain last year was the most since 2002, and exceeded the 4.54 for government bonds globally.
Colombia's 10-year breakeven rate fell to 2.7 per cent on January 23, the lowest since February 2012 when Bloomberg started compiling the data. Colombia's bonds gained eight per cent the past three months, the most since February 2012, JPMorgan data show.
South Korea's policy makers may cut the nation's benchmark to 2.5 per cent from 2.75 per cent in six months, while Poland's central bank will lower its rate by half a percentage point to a record low of 3.25 per cent, Morgan Stanley data show.
Opposite direction
At the same time inflation is slowing, so is the economy. The IMF cut its growth forecast for emerging markets this year by 0.1 percentage point to 5.5 per cent on January 23, citing weaker demand from advanced economies. That compares with an average growth rate of 6.6 per cent over the past decade.
In developed economies, the outlook for inflation is moving in the opposite direction as central banks attempting to stimulate growth buy sovereign debt securities to pump money into the financial system and contain long-term borrowing costs.
The US five-year breakeven rate reached a four-month high of 2.36 percentage points on February 1, above the average of 1.96 percentage points in the 10 years through 2012. The gauge for the UK jumped to 2.87 percentage points on February 5, the highest since April 2011.
Inflation in emerging markets won't accelerate in a "particularly strong way," making bonds from these regions more attractive than those in the developed world, Phillip Apel, the head of diversified fixed-income and rates at Henderson Global Investors Ltd, said in an interview from Singapore on January 25.
Little protection
"Government bonds in developed markets are out of favor," Apel, who manages about $105 billion from London. They offer "little protection against a rise in yields."
Emerging-market bonds returned 17 per cent in dollar terms last year, the most since 2009. Yields average 3.47 percentage points above Treasuries on February 1, the least since April 2011. The spread is 0.18 percentage points above the average over the past decade.
Investors poured a record $1.3 billion into funds dedicated to emerging-market local-currency bonds in the week through February 6, according to Morgan Stanley, citing data compiled by EPFR Global. They withdrew $300 million out of dollar-denominated emerging-market bond funds, the biggest outflow since June.
Brazil is one emerging market that will see elevated inflation, based on bond yields. The nation's consumer price index will average 5.5 per cent by 2014, according to breakeven data compiled by Bloomberg. The gauge reached 6.12 per cent on January 8, the highest level since September.
Prices jump
Brazil's consumer prices jumped 6.15 per cent in the year through January, the fastest pace in a year. Inflation has been above 4.5 per cent, the midpoint of the central bank's target of 2.5 per cent to 6.5 per cent for the last 29 months even as the economy expanded at the second slowest pace since 1999.
Turkey's inflation will average 6.1 per cent in two years, compared with the government's target of five per cent, breakeven rates show. In Asia, rising exports and a growing Chinese economy is lifting inflation estimates in the region.
The Philippines will raise benchmark rates three times this year to stem inflation, according to Michael Spencer, Deutsche Bank AG's chief Asian economist.
"The world has priced in for permanently low inflation," Paul McNamara, who oversees $9 billion in emerging-market debt at GAM Investment in London, said in a telephone interview on January 28. "There's no question that it is going to shoot up. Is it going to be a big problem? No. Normalization? Yes."
McNamara said he's reducing holdings of longer-dated fixed- rate bonds and buying inflation-linked debt securities.
'Dovish Stance'
Most emerging-market central banks will delay raising borrowing costs and tolerate faster price increases to cement the economic recovery, benefiting inflation-linked bonds over fixed-rated securities, according to Koon Chow, head of emerging-market strategy in London at Barclays Plc.
"Emerging market central banks will be reluctant to change course on monetary policy," Chow, who recommends buying Polish CPI-linked bonds, wrote in a Jan. 25 e-mail. "This will probably help a majority of central banks hold a more dovish stance."
Central bankers see little chance of a repeat of 2010. The S&P index of commodities is 11 percent below its peak in August 2011. Food prices tracked by the United Nations fell 0.5 percent last year, extending its drop to 12 percent since the peak in February 2011. Food costs accounted for 27 percent of consumer price indexes in developing nations, compared with 16 percent in developed economies, according to Bank of America.
Surprise Index
Citigroup's surprise index tracking average consumer price increases in emerging markets relative to economists forecast fell to minus 18.9 in January, the lowest reading since November 2009. A negative reading suggests the actual inflation report trails economists forecast, while a positive number indicates higher-than-expected consumer price increases. The measure reached 7.4 in March 2011, the highest since October 2008.
India lowered its benchmark repurchase rate on Jan. 29 to 7.75 percent from 8 percent, marking the first cut since April, as inflation fell to a three-year low.
Hours later, Hungarian policy makers cut their main rate for a sixth month, reducing the two-week deposit rate a quarter- point to 5.5 percent, the lowest since March 2010.
It would take greater-than-forecast growth and a 25 percent surge in food prices to really "get inflation going," according to Alberto Ades, head of emerging-market fixed-income strategy at Bank of America. Even in that scenario, inflation will be 1.1 percentage points lower than the July 2011 peak, strategists led by Ades wrote in a note on Jan. 24.
"We like emerging market local bonds," Lazlo Belgrado, a money manager who helps oversees about $20 billion in emerging- market debt at KBC Asset Management SA, said by phone from Luxembourg. 'It's too early for the growth-driven inflation scare.''