One emerging-market worry gives way to another

DESPITE THEIR supposed dynamism, emerging markets often struggle to escape their past. A few months ago, investors worried that this year would turn out to be a repeat of 2013, when rising bond yields in America prompted a sharp sell-off in emerging markets, known as the taper tantrum. Now investors are worried that 2021 will be a grim repeat of last year, as another, more virulent wave of covid-19 infections spreads through Brazil, India and elsewhere.

To give shape to these fears, analysts have been busy drawing up lists of the most vulnerable countries, based on everything from inflation to infection rates. They have been looking for this year’s successors to the “fragile five” (Brazil, India, Indonesia, South Africa and Turkey), the countries that were hardest hit by the taper tantrum eight years ago. So it is notable that the man who named the original five, James Lord of Morgan Stanley, a bank, has chosen this moment to turn “outright bullish” on some emerging-market assets, telling his clients to “buy local bonds”. What explains his calm in the face of calamity?

The calamity is, after all, undeniable. India’s second wave is terrifying but not unique. The recorded number of new infections per 1m people is still higher (over the past two weeks of data) in Argentina, Brazil, Chile, Colombia and Turkey than in India. JPMorgan Chase, another bank, last week cut its growth forecasts for India and Brazil, following earlier cuts for the Philippines and much of central Europe. It now expects the combined GDP of emerging markets (excluding China) to grow by 5.9% this year. That is barely any faster than the pace expected of developed markets (which are projected to grow by 5.7%) and would leave emerging-market GDP only 1% bigger than in 2019.

But even as the covid-19 wave is repeating itself, the bond tantrum is not. The yield on ten-year American government bonds has stopped rising and slipped back below 1.6%, despite strong data on jobs, housing, manufacturing and retail sales in the world’s biggest, boomiest economy. The “real” yield on inflation-protected bonds is now -0.7%, about the same as it was at the end of February. If the American bond market remains this well behaved in the coming months, then foreign investors will find it harder to resist the spicier rewards offered by bonds denominated in the rand, real or rupiah.

Indeed, one reason why the tantrum has receded is because the virus has not. As the pandemic begins to interrupt the emerging world’s economic recovery, their central banks will surely worry less about any gathering inflationary pressure. Morgan Stanley believes that central banks in Brazil, Russia and Mexico among others are unlikely to raise interest rates as sharply as markets now expect. The delayed recovery is bad for emerging economies, but not necessarily bad for their governments’ paper. Bonds usually do well when growth is slow and central banks are doveish, notes Mr Lord.

He nonetheless acknowledges two dangers to this view. One is that American bond yields start climbing again sooner than he expects. Another risk is that the delayed recovery in a big emerging economy turns into something worse, frightening investors and raising worries about the government’s creditworthiness. In that case, the price of local bonds would fall (and yields would rise), even in the absence of any threat of inflation. In the rich world, people flock to their governments’ bonds even in the worst of times. In the emerging world, investors unfortunately do likewise, flocking to rich countries’ assets and abandoning their own. That is another way in which emerging economies remain trapped by their past. ■