德银-新兴市场-宏观策略-新兴市场地方利率：溢价衡量-2019.2.15-25页_1mb

EM Local Rates: Measuring Premium - The Shrinking Cushion

Core Content

This report discusses the evolution of Term Premium (TP) in Emerging Market (EM) local fixed income (LFI) and its implications for investment strategy. TP has historically been a key component of value and cushion for EM rates, especially during periods of monetary tightening. The report highlights that TP has declined significantly since early November 2018, moving back to post-tantrum average levels, which has impacted the valuation and performance of EM LFI.

Main Takeaways

• Term Premium (TP) has been an important factor in EM rates, providing a cushion for duration during hiking cycles.
• TP reached extreme levels in early November 2018, which allowed for a broad-based strong performance in EM LFI (FX-hedged), but has since compressed.
• The TP compression, combined with low real rate differentials between EM and Developed Markets (DM), suggests reduced upside potential for EM LFI.
• Risk-neutral rates (RN) have stabilized, indicating that the recent rally in EM LFI is primarily due to TP compression rather than RN changes.
• TP is still relatively high in Peru, Brazil, Colombia, and South Africa, offering higher returns on duration, while South Korea, Turkey, Thailand, and the Czech Republic have already seen TP compression to near historical lows.

Key Drivers of TP

• TP is largely influenced by policy rates and core rates.
• During hiking cycles, Latin America (LatAm) curves tend to provide the largest cushion for duration, whereas Asia curves are more vulnerable.
• Czech Republic, Mexico, Peru, Hungary, and Romania are most sensitive to core rates, while Brazil, Chile, Colombia, Russia, and Turkey show little sensitivity.
• In addition to policy and core rates, inflation, FX, credit risks, and UST yields also play a role in driving TP for certain countries.

TP vs Swap TP: Basis Dislocations

• The basis between bond TP and swap TP is at historical highs in Mexico, Malaysia, South Africa, and Thailand, while it is the opposite for Brazil.
• The basis has narrowed in CEEMEA and LatAm since November 2018, but has widened in Asia.
• Brazil has seen the largest drop in the basis (80bp), while India and Malaysia have seen increases of about 25bp.
• Mexico, Malaysia, South Africa, and Thailand currently exhibit the most significant basis dislocations.

Strategy Implications

• TP remains a strong signal for duration selection, with higher TP rankings indicating higher expected returns.
• Peru, Brazil, Colombia, and South Africa are top-ranked for duration returns, while Turkey, South Korea, Thailand, and the Czech Republic are at the bottom.
• EM LFI is one of the most idiosyncratic asset classes, and investors need to be more selective in light of the compressed TP.
• India is currently the most attractive EM LFI market due to its top rankings in both valuation and expected returns.
• Chile and Mexico show the highest normalized residuals, indicating potential value in their bond markets.

Summary Table of TP and Valuation

Conclusion

The term premium in EM LFI has significantly declined since early November 2018, reducing the cushion for duration. While TP is still high in several LatAm and CEEMEA countries, it has compressed in others, especially in Asia. The report emphasizes that investors should focus on TP as a key signal for duration selection and that certain countries like India and Mexico still offer value. However, with TP shrinking, the upside potential for EM LFI is limited, and a more selective approach is necessary.