Bond Strategists: CSFB Sees Emerging-Market Declines (Update1)
Bond Strategists: CSFB Sees Emerging-Market Declines
March 31 (Bloomberg) -- Investors should steer clear of emerging-market bonds because they may be poised to decline further after their worst quarterly performance since June 2004, according to Credit Suisse First Boston.
The debt of developing nations may extend declines as investors price in larger interest-rate increases by the U.S. Federal Reserve, Filippo Nencioni, CSFB's global head of sovereign strategy, wrote in a report published yesterday.
``We need to see a U.S. interest rate market that reflects quite high expectations of larger Fed hikes,'' Nencioni wrote from New York. ``Any rallies would prove short-lived and going forward we expect more downside to asset prices.''
Nencioni's forecast contrasts with that of Mohamed El-Erian at Pacific Investment Management Co., who said on March 22 investors should take advantage of the declines to increase their emerging-market debt holdings. CSFB is the fifth-biggest underwriter of emerging-market bond sales this year, according to data compiled by Bloomberg.
Emerging market bonds, stocks and currencies fell this month as investors shunned riskier assets on concern rising oil prices will stoke inflation, prompting the Fed to boost the size of interest-rate increases. Last week, emerging market equity funds had their worst week since May 2004, with net outflows of $761.9 million, EmergingPortfolio.com reported.
``Fund flows have started to show the first outflows, albeit small,'' Nencioni wrote. ``We would expect the outflows to continue.''
Fed Decision
The Fed on March 22 lifted the target rate for overnight lending between banks to 2.75 percent and repeated a plan to carry out rate increases at a ``measured'' pace. In a statement accompanying the decision, the central bank said ``pressures on inflation have picked up in recent months.''
The statement led traders and investors to increase bets that policy makers will raise rates by 50 basis points for the first time since May 2000.
Interest-rate futures show traders are pricing in about a 24 percent chance the Fed will raise its target for overnight bank lending by a half point at its next meeting on May 3. As recently as Feb. 11, traders were pricing in no chance of such a move.
``With the recent changes in language by the Fed and the recent inflation data, we think the market will at some point have to price in more negative scenarios,'' Nencioni wrote. ``In the process, we think emerging market spreads will widen further.''
The average extra yield, or spread, investors demand to buy emerging market bonds instead of U.S. Treasury notes was unchanged today at 3.87 percentage points, according to JPMorgan Chase & Co.'s EMBI Plus Index, up from 3.3 percentage points on March 8.
`Keep Cash'
``Only later on, in our view, will it be time to buy back bonds and go towards being fully invested in'' emerging-market debt, Nencioni wrote. ``We have in the past recommended raising cash balances. We would keep this cash for now.''
Emerging market bonds have handed investors a 1.2 percent loss this quarter, including reinvested interest, according to a Merrill Lynch & Co. index. The bonds lost 3.1 percent in the second quarter of last year. Merrill's index of all sovereign debt is up 0.4 percent for the first quarter.
Investors should place bets that the yield gap of Brazilian, Turkish and Venezuelan bonds maturing in 10 years and 30 years will narrow, wrote Credit Suisse's New York-based analysts Igor Arsenin and Linan Liu, in a separate report published today.
``Curve flattening trades are still attractive in the current environment in which emerging-market spread movement is expected to stay volatile, because these trades naturally have a bearish bias,'' the analysts wrote.
Curve flattening occurs when shorter-dated securities fall, longer dated notes gain or when both occur at the same time.
CSFB has arranged 15 emerging-market debt sales worth $3.6 billion this year, according to Bloomberg data. Citigroup Inc. is the biggest with 13 deals worth $5.3 billion.
Nencioni's research team was runner up in Institutional Investor magazine's annual award for emerging-market strategy in 2003.
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