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EM Traders Buy Local Debt as Election Shocks Upend FX Bets

Maria Elena Vizcaino, Vinícius Andrade and Davison Santana

10 June 2024 at 5:24 am·4-min read

(Bloomberg) -- Emerging-market investors are turning to local bonds and relative-value currency trades in the aftermath of election shocks that crushed long-standing bets in some of the largest developing economies.

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Ashmore Plc and Ninety One are among those adding to positions in local debt, particularly in frontier markets. Others are recommending currencies like the Polish zloty, seen as relatively insulated from political turbulence after volatility roiled popular carry trades like the Mexican peso. Turkish assets are also emerging as a favored bet.

European Union election results at the weekend added another layer of complexity, sending the euro weaker after far-right parties made gains in several countries.

“We’ve been increasing the frontier risk, through both local bonds and FX derivatives,” said Christine Reed, a portfolio manager at Ninety One. “We like the story in Egypt, we like some of the stories in smaller Latin American names. We’re trying to diversify and not load up” where positioning is heavy, she added.

Reed is also paying more attention to Turkey amid what she called “a constructive outlook.”

The country overhauled economic policies and appointed a team of investor-friendly officials after elections last year, a dramatic turnaround following a years-long experiment with unconventional policies based on ultra-low interest rates, which sent investors fleeing. The changes, in turn, have fueled a surge in demand for local-currency assets. Total foreign holdings of Turkish lira-denominated government bonds have risen 10-fold in a year.

“It’s a fundamental story supported by the central bank, which has hiked a lot and the inflation trajectory is coming down,” Valentina Chen, co-head of emerging-market debt at Mackay Shields in London, said of the lira. “You get compensated very well.”

The search for new pockets of returns intensified after a string of election surprises roiled some of the best trades of 2024. Mexico’s peso posted the worst week since the onset of the pandemic, with volatility spiking as traders dumped one of the most crowded trades in currencies on the prospect of reforms that could increase government meddling in the economy after Claudia Sheinbaum’s landslide win.

The peso rebounded slightly on Monday as Sheinbaum’s coalition ended up falling just short of the supermajority needed to make changes to the constitution.

“Mexico is a good story, which got a bit muddled,” said Gustavo Medeiros, head of research at Ashmore in London. The firm has positions in countries including Egypt, Nigeria and Turkey, he said. “We have a bigger exposure in rates than FX across the board.”

Bartosz Sawicki, a market analyst at Polish brokerage Cinkciarz.pl, said investors could look at Poland, as the zloty — which up until last week had performed in line with Mexico’s peso — benefits from high carry and low political uncertainty. Others are looking at relative value trades while reducing exposure to EM currencies. T Rowe Price, for example, is buying the Colombian peso while selling its Chilean counterpart.

“During risk-off periods EM FX carry trades tend to underperform because they’re riskier than safe haven currencies,” said Aaron Gifford, a sovereign analyst at T Rowe in Baltimore. “So it’s better to do relative value trades where you can isolate that risk.”

Moving Forward

Analysts at Citibank argued that even though fundamentals may have been marginally impacted, such unwinds historically have been followed by outperformance. “While the positioning clean up may have slightly longer to run,” carry should recover “sooner rather than later,” they said.

“It’s common for investors to get scared as an election goes through, but then weeks go by and they realize there’s continuation,” said Carlos Carranza, a portfolio manager at Allianz Global Investors in London, referring to Mexico and India. “And if there’s continuation, there’s carry.”

But election uncertainty is far from over. The forint weakened Monday after the EU ballots, which saw Prime Minister Viktor Orban’s dominance of Hungarian politics slightly dented. Investors will also have to contend with votes in the UK and US in coming weeks and months, all of which could spark fresh volatility.

“We see cleaner positioning as a positive technical factor, but more importantly for us is a country’s monetary and fiscal policy stance, and inflation and growth profiles,” said Mackay Shields’ Chen. “Otherwise, we are running the risk of picking up pennies in front of a steamroller.”

What to Watch

Money managers will turn their attention to a string of economic data from India, where prints for inflation, industrial production and trade are due
Hungarian consumer price increases quickened in May as the country’s central bank edges closer to ending its rate cuts, which have lasted for more than a year.
Consumer prices data also due in Colombia and Brazil will provide clues on the next moves of the nations’ central banks

--With assistance from Zijia Song, Ronojoy Mazumdar and Andras Gergely.

(Updates with EU election results, Mexican peso move.)

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