Bond Traders Whip CPI Angst as India to Hungary Cut Rates By Ye Xie and David Yong - Feb 13, 2013

From Mexico to Poland, bond investors are lowering their outlook for inflation in developing markets to a nine-month low, giving central bankers room to cut interest rates and boost their economies.
The difference between fixed-rate bond yields and those indexed to consumer prices show investors expect Mexico’s inflation to average 3.22 percent in the next two years, near the slowest since May. A similar Polish measure fell to 2.09 percent last month, the lowest since at least April. Emerging- market bonds gained 5 percent in dollar terms during the three months through yesterday, the most in a year, compared with 0.1 percent for government securities worldwide, JPMorgan Chase & Co. and Bank of America Corp. indexes show.
“We see only moderate growth compared to recent years, and these solid but hardly effervescent economic conditions should keep inflation in check,” Alessandro Bee, an economist and fixed-income strategist in Zurich at Bank Sarasin & Cie AG, which oversees 99 billion Swiss francs ($108 billion), said in a phone interview on Feb. 4. “That’s a really nice environment for local bond markets.”
While investors see inflation in the biggest emerging markets such as China and Brazil rising, the tame outlook elsewhere will allow policy makers to focus on bolstering the weakest economic growth since 2009 through lower rates, according to Bank of America.

IMF View

The rate of inflation in developing markets will remain at 6.1 percent in 2013, slowing from a four-year high of 7.2 percent in 2011, the International Monetary Fund in Washington said last month.
India, Poland, Colombia and Hungary have cut borrowing costs this year, in part because consumer prices are under control. Traders anticipate looser monetary policy in South Korea, Poland, Colombia and Hungary, according to a Morgan Stanley model that tracks interest-rate swaps.
That’s a reversal from two years ago, when a 55 percent jump in the Standard & Poor’s GSCI index of 24 raw materials in 11 months through April 2011 pushed up consumer prices and led central banks from China to Brazil to raise borrowing costs.
Brazil boosted rates 3.75 percentage points to 12.5 percent in the 15 months through July 2011. China lifted its one-year lending rate five times in nine months starting October 2010.

Growth Throttled

Those moves throttled emerging-market growth to 6.3 percent in 2011 from 7.4 percent the year before, and punished bond investors, with JPMorgan’s GBI-EM Global Diversified Index losing 4.9 percent in dollar terms between mid-October 2010 and mid-January. That was worse than the loss of 3.6 percent for government securities worldwide, according to the Bank of America Merrill Lynch Global Government Index.
In Mexico, central bank board members led by Governor Agustin Carstens unanimously decided to leave the benchmark interest rate at a record low 4.5 percent on Jan. 18, and signaled this month that they may lower borrowing costs for the first time since 2009 as inflation moderates.
Consumer prices in Mexico rose at a 3.25 percent annualized rate in January, the slowest pace since October 2011, after falling within the central bank’s target range of 2 percent to 4 percent in December for the first time since May.

Slower Pace

Banco de Mexico may cut rates “if we keep advancing in this convergence process” with inflation moving closer to 3 percent in a “sustainable way,” Carstens said told reporters in Mexico City today.
The two-year breakeven rate in Mexico narrowed from a 16- month high of 4.54 percentage points in July, according to data compiled by Bloomberg. The rate averaged 4.04 percentage points since October 2006, when Bloomberg started compiling the data.
Peso-denominated bonds returned 4.5 percent in January, the most since June, Bank of America indexes show. The 21 percent gain last year was the most since 2002, and exceeded the 4.54 percent for government bonds globally.
Colombia’s 10-year breakeven rate fell to 2.7 percent on Jan. 23, the lowest level since February 2012, when Bloomberg started compiling the data. Colombia’s bonds gained 8 percent in the past three months, the most since February 2012, JPMorgan data show.
South Korea’s policy makers may cut the nation’s benchmark to 2.5 percent from 2.75 percent in six months, while Poland’s central bank will lower its rate by a half-percentage point to a record low 3.25 percent, Morgan Stanley data show.

Opposite Direction

At the same time inflation is slowing, so is the economy. The IMF cut its growth forecast for emerging markets this year by 0.1 percentage point to 5.5 percent on Jan. 23, citing weaker demand from advanced economies. That compares with an average growth rate of 6.6 percent over the past decade.
In developed economies, the outlook for inflation is moving in the opposite direction as central banks attempting to stimulate growth buy sovereign-debt securities to pump money into the financial system and contain long-term borrowing costs.
The U.S. five-year breakeven rate reached a four-month high of 2.36 percentage points on Feb. 1, above the average of 1.96 percentage points in the 10 years through 2012.
The gauge for the U.K. climbed today to 2.88 percentage points, the highest since April 2011. Britain faces a further bout of inflation and a muted economic recovery, Bank of England Governor Mervyn King said in London.
Inflation in emerging markets won’t accelerate in a “particularly strong way,” making bonds from these regions more attractive than those in the developed world, Phillip Apel, the head of diversified fixed income and rates at Henderson Global Investors Ltd., said in an interview from Singapore on Jan. 25.

Little Protection

“Government bonds in developed markets are out of favor,” said Apel, who manages about $105 billion from London. They offer “little protection against a rise in yields.”
Emerging-market bonds returned 17 percent in dollar terms last year, the most since 2009. Yields average 3.47 percentage points above Treasuries on Feb 1, the least since April 2011. The spread is 0.18 percentage point above the average over the past decade.
Investors poured a record $1.3 billion into funds dedicated to emerging-market local-currency bonds in the week through Feb. 6, according to Morgan Stanley, citing data compiled by EPFR Global. They withdrew $300 million out of dollar-denominated bond funds, the bank said in a Feb. 7 report.
Brazil is one emerging market that will see elevated inflation, based on bond yields. The nation’s consumer price index will average 5.5 percent by 2014, according to breakeven data compiled by Bloomberg. The gauge reached 6.12 percent on Jan. 8, the highest level since September.

Prices Jump

Brazil’s consumer prices jumped 6.15 percent in the year through January, the fastest pace in a year. Inflation has been above 4.5 percent, the midpoint of the central bank’s target of 2.5 percent to 6.5 percent for the last 29 months even as the economy expanded at the second slowest pace since 1999. Inflation is at a high level that requires attention, the central bank said Feb. 7.
Turkey’s inflation will average 6.1 percent in two years, compared with the government’s target of 5 percent, breakeven rates show. In Asia, rising exports and a growing Chinese economy is lifting inflation estimates in the region.
The Philippines will raise benchmark rates three times this year to stem inflation, according to Michael Spencer, Deutsche Bank AG’s chief Asia economist.
“The world has priced in for permanently low inflation,” Paul McNamara, who oversees $9 billion in emerging-market debt at GAM Investment in London, said in a telephone interview on Jan. 28. “There’s no question that it is going to shoot up. Is it going to be a big problem? No. Normalization? Yes.”
McNamara said he’s reducing holdings of longer-dated fixed- rate bonds and buying inflation-linked debt securities.

‘Dovish Stance’

Most emerging-market central banks will delay raising borrowing costs and tolerate faster price increases to cement the economic recovery, benefiting inflation-linked bonds over fixed-rated securities, according to Koon Chow, the head of emerging-market strategy in London at Barclays Plc.
“Emerging market central banks will be reluctant to change course on monetary policy,” Chow, who recommends buying Polish CPI-linked bonds, wrote in a Jan. 25 e-mail message. “This will probably help a majority of central banks hold a more dovish stance.”
Central bankers see little chance of a repeat of 2010. The S&P index of commodities is 11 percent below its peak in August 2011. Food prices tracked by the United Nations fell 0.5 percent last year, extending its drop to 12 percent since the peak in February 2011. Food costs accounted for 27 percent of consumer price indexes in developing nations, compared with 16 percent in developed economies, according to Bank of America.

Surprise Index

Citigroup’s surprise index tracking average consumer price increases in emerging markets relative to economists’ forecasts fell to minus 18.9 in January, the lowest reading since November 2009. A negative reading indicates the actual inflation report trails economists’ forecasts, while a positive number indicates higher-than-expected consumer price increases. The measure reached 7.4 in March 2011, the highest since October 2008.
India lowered its benchmark repurchase rate on Jan. 29 to 7.75 percent from 8 percent, marking the first cut since April, as inflation fell to a three-year low.
Hours later, Hungarian policy makers lowered their main rate for a sixth month, reducing the two-week deposit rate by a quarter-point to 5.5 percent, the lowest since March 2010.

‘Too Early’

It would take greater-than-forecast growth and a 25 percent surge in food prices to really “get inflation going,” according to Alberto Ades, head of emerging-market fixed-income strategy at Bank of America. Even in that scenario, inflation will be 1.1 percentage points lower than the July 2011 peak, strategists led by Ades wrote in a note on Jan. 24.
“We like emerging-market local bonds,” Lazlo Belgrado, a money manager who helps oversees about $20 billion in emerging- market debt at KBC Asset Management SA, said by phone from Luxembourg. ‘It’s too early for the growth-driven inflation scare.’’
To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; David Yong in Singapore at dyong@bloomberg.net
To contact the editors responsible for this story: Robert Burgess at bburgess@bloomberg.net; James Regan at jregan19@bloomberg.net

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