Brexit triggers surprise
emerging market asset rally
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[July 02, 2016]
By Dion Rabouin
NEW YORK (Reuters) - When British voters
shocked world markets by voting to leave the European Union last week,
emerging markets assets seemed among the most vulnerable to a full-on
retreat to safe havens from riskier investments.
Yet as investors have realized that the vote and the resulting
uncertainty will probably keep the U.S. Federal Reserve on the
sidelines at least until December, emerging currencies, stocks and
sovereign bonds have stormed higher - outpacing a wider market
bounce-back from the initial Brexit rout.
MSCI's emerging equity index is set for its biggest weekly gain
since March, while yields on debt denominated in emerging currencies
such as rouble and the Brazilian real have fallen as much as 50
basis points over the week.
"Janet Yellen has made it clear that events outside of the U.S. will
have a bearing on the Fedís decision making and she was explicit
about the risk that she thought Brexit would pose," said Viktor
Szabo, Senior Investment Manager at Aberdeen Investment Management.
"This pause from the Fed is going to support emerging markets."
Latin American currencies have been particularly well bid, with the
Brazilian real near its highest level in almost a year, the Chilean
peso at a one-month high and the Mexican peso on course for its best
four-day streak since early 2010.
Underlining the renewed appetite for emerging market assets,
Argentina announced on Thursday an offer of $2.75 billion in bonds,
just three months after the country's historic return to the
international capital markets.
Brazilian dollar bonds also saw strong investor demand with
JPMorgan's index tracking the country's sovereign debt up more than
4 percent since Tuesday while Mexican debt has gained 3.8 percent.
The average yield premium demanded by investors to hold emerging
debt over Treasuries has fallen by 30 basis points since Monday.
To be sure, the rally may not be sustainable. Brazil still faces
record deficits and expects to remain in a recession next year while
Mexico's peso had drifted to a record low against the dollar prior
to this week's action. A set of particularly strong U.S. data might
also rekindle Fed rate rise expectations, putting emerging
currencies under pressure again.
But for now, investors like what they're seeing from these assets.
"Emerging markets are in a good place with 'one and done' Fed," Bank
of America Merrill Lynch told clients, referring to the likelihood
the Fed will not raise rates again this year.
Typically, the uncertainty triggered by an event like Brexit would
prompt investors to flee riskier emerging market assets, but
pessimists may have underestimated the positive effect of increased
liquidity in markets.
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A British flag flutters in front of a window in London, Britain,
June 24, 2016 after Britain voted to leave the European Union in the
EU BREXIT referendum. REUTERS/Reinhard Krause
Not only have markets effectively priced out a Fed rate rise this year, Bank of
England Governor Mark Carney on Thursday signaled more policy easing to counter
the negative economic effects of Britons' vote to quit the EU.
Expectations of further stimulus are also building in the euro zone, Japan and
Since the Brexit vote more than $1 trillion worth of bonds have joined the
negative-yield club, with more than $11.7 trillion worth of debt worldwide now
estimated to be yielding less than zero.
U.S. 10-year bond yields are just a whisker off record lows while the dollar's
retreat is lifting emerging currencies, with Brazil's real moving below 3.20
reais per dollar for the first time in a year on Thursday.
The Mexican peso was on pace to gain more than 4 percent against the dollar
since Tuesday, lifted partly by a half-point interest rate rise.
Local currency bonds, already among this year's best performing assets with
gains of around 15 percent in dollar terms, are on a roll.
Here Latin America is benefiting less than other regions given interest rates
look unlikely to fall - Brazil's central bank governor for instance said it was
too early to cut rates.
But across emerging Asia benchmark 10-year bond yields have fallen between 20
and 40 basis points in the past week. Russian yields are at the lowest since
February 2014 while South African yields fell to seven-month lows, down 50 bps
in the past week.
"If you look at real yields in G4 they have fallen very sharply," said Unicredit
strategist Kiran Kowshik, referring to the grouping of Britain, euro zone,
United States and Japan. "And typically when real yields fall you tend to see a
search for yield in emerging markets."
(Reporting by Dion Rabouin; Additional repoting by Sujata Rao in London; Editing
by Tomasz Janowski)
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