Asset AllocationAugust 16, 2022

PIMCO Sees Opportunity in Emerging Markets Bonds

Central banks in emerging markets have hiked at different speeds, with the best currency gains going to an aggressive Brazil.

Reported by Larry Light

The big story in the currency realm has been the spiral of the U.S. dollar, up 11.4% against a basket of leading currencies, during the Federal Reserve’s tightening campaign. But to PIMCO, other opportunities beckon—namely, in emerging markets, whose economies and currencies have had a wild ride amid the pandemic, the Russia-Ukraine war and rampant inflation.

Nevertheless, not all of them are promising, according to a report from Pramol Dhawan, who leads the asset manager’s emerging markets portfolio management, and Lupin Rahman, head of EM sovereign credit portfolio management. There’s a “case for relative value opportunities within EM investing,” they wrote, which “may offer opportunities for portfolio diversification.”

Investors would benefit by favoring bonds from nations whose central banks have robustly ratcheted up interest rates to fight inflation, in PIMCO’s estimation. These bonds will do the best going forward, the firm said.

EM nations differ in their approach to fighting inflation, the report notes. The most energetic is Brazil, where the central bank has hiked its benchmark to 13.25%, from 2% at the start of 2022. This appears to be having an effect: Inflation ticked down to 10.1% in July, from a high of 12.1% in April.

In Poland, though, the hiking has been relatively low-key. The central bank’s benchmark has gone up to 6.5% recently, from 2.2% to start this year. Inflation is still on the rise, hitting 15.6% last month, from 9.4% at the year’s start.

The two nations have different inflation drivers. For Brazil, the global fall of commodities prices has been a problem. But that situation appears to be easing; the Dow Jones Commodity Index has dipped 14% from its June high.

For Poland, the proximity of the Russia-Ukraine conflict has taken a toll, with no end in sight. The war, the report says, “has had an outsized effect on refugee inflows, supply chains, spending pressure and commodity prices.”

In currency terms, however, the contrast is stark. Brazil’s real has leapt up 11% this year compared with the dollar. The Polish zloty has slipped 8.3% against the buck.

The PIMCO paper notes that the EM overall economic picture remains unclear. Going all-in on EM fixed income generally would require an obvious trend to justify the exercise, it argues, “particularly in the wake of past false starts.” So for now, the answer is to be choosy. Once more Brazils are in place, as opposed to Polands, the report advises, “it could mark a major break from the past decade of U.S. dollar dominance.”

Meanwhile, the report sees “reason for caution now given the uncertain influence of global risk factors, such as those stemming from the war in Ukraine.” The present climate suggests “shying away from local Polish bonds and instead emphasizing local Brazilian bonds.”