Fixed Income  

Emerging market bond inflows may start ‘reversing’

Mike Riddell, the government bond tsar at M&G Investments, has warned of a potential crunch in emerging market local currency fixed income.

The manager said bonds denominated in emerging market local currencies, such as Mexican peso, Malaysian ringgit and South African rand, looked risky as the US dollar rallied and Chinese growth weakened.

He cited a significant ramping up of foreign ownership of the emerging bonds in recent years that could quickly start “reversing”.

Emerging local currency bonds have seen significant and persistent inflows from international investors since the turn of the millennium – a trend that has escalated since the 2008 financial crisis for some markets.

Mr Riddell co-manages the group’s £1.1bn Global Macro fund with Jim Leaviss.

The recent Global Financial Stability Report from the International Monetary Fund (IMF) had shown that while in 2002 a total of 4 per cent of flows from advanced economies went into emerging markets, that figure was now 10 per cent.

Mr Riddell said this “surge” made him “very nervous” and warned this trend could suddenly reverse and leave investors with an exit door that was “quickly narrowing”.

“If you have a strong dollar and if you have the Fed hiking interest rates, then that encourages money to flow out of emerging markets and back into the US,” he said.

“[Money flowing in] has been a very big tailwind for emerging markets in the past 10 years but it could turn into a headwind if you believe the US is going to hike rates.”

China has also been a major tailwind for emerging markets, particularly Asia, for the past 10 to 15 years, but Mr Riddell said that could also turn into a headwind if China’s growth slows dramatically.

The manager believes such a slowdown is fairly likely because, in his view, the current official growth rate of approximately 7.5 per cent is “essentially fabricated”.

Instead of looking at the official figure, Mr Riddell advised following the advice of Li Keqiang, now the premier of China, who in 2007 said Chinese data was “man-made” and “unreliable”.

Mr Keqiang had said he instead focused on just three areas of data: railway trade, bank lending and power consumption.

Based on an index of the data by US firm Citi, Mr Riddell claimed these key indicators were now almost down to the trough seen after the collapse of Lehman Brothers at the peak of the financial crisis.

Mr Riddell said while the official growth rate was 7.5 per cent, the Citi index showed “things are a lot worse than that”.

“If you put these things together then we are very worried that at some point if the Fed starts hiking, then these flows will start reversing and you’ll find the exit door is really quite narrow,” he said.

Mr Riddell added he is most bearish on emerging market debt on the M&G fixed income desk but stated the whole team was cognisant of the risks in the region at the moment.