Where the real yields are

Elevated real yields in certain pockets of emerging markets offer more compelling fixed income opportunities than developed markets - even as interest rates stay ‘higher for longer’ in the US. 



Emerging market (EM) bonds are often seen as exotic and risky, while their developed market (DM) counterparts offer sanctuary and stability. But this week’s Chart Room, which highlights the real policy rates in major EMs and DMs, shows the tables have turned.

Among the countries dubbed the ‘Fragile Five’ in the wake of the taper tantrum over a decade ago, India and Indonesia have made hard fought gains to preserve fiscal and monetary credibility. The worst may also be behind Brazil, South Africa, and Turkey, which have all overcome economic and institutional challenges. Most notably, in Turkey, policymakers have pivoted back to orthodoxy.

For the most part, EM inflation is pretty much around target today thanks to ongoing disinflationary forces; some countries such as China and Thailand have practically no inflation or even deflation. EM monetary policy is tight with real yields as high as they were before the Global Financial Crisis, supported by prudent rate cuts. Indonesia even did a surprise hike recently.

Growth is also starting to improve - just look at India’s performance over the last year or so.

Meanwhile, DMs are arguably behaving like the EMs of yesteryear. G7 net government debt is over double the level of EM. US inflation is stubbornly high and fiscal policy is profligate.

The UK was punished by markets for its own lack of fiscal discipline towards the end of 2022. The Bank of Japan has been so behind the curve keeping real yields negative (despite making substantial progress in achieving its inflation target) that the yen has nosedived.

That’s why we look at US 10-year government bonds yielding north of 4.5 per cent with little excitement. No longer able to provide the negative correlation to equities that multi asset investors prize, the US looks less exceptional. Today, it is the likes of Brazil, Mexico, and South Africa that can provide equity-like returns with a good margin of safety. Backed by stronger growth and better valuations, in our opinion EMs are where the real yields are.