Investors are wondering how the Fed’s tapering talks will affect their portfolios. Importantly, the tapering talks come at a crucial time when SA investors have piled into SA bonds.
The last time we witnessed a serious taper tantrum was in 2013 after the then-Fed Chairman Ben Bernanke suggested dialing down on the bank’s asset purchase programme which it had started five years earlier as a response to the global financial crisis. The surprise announcement precipitated a plunge in emerging equities and bonds as capital – approximately $30bn – flew back to developed markets on expectations that a rise in US interest rates would enhance the appeal of “safe” assets such as US government bonds at the expense of riskier emerging markets assets. Emerging market currencies were hit hard as forex reserves were depleted quickly which to some extent impaired some emerging markets’ ability to repay interest obligations on dollar-denominated debt.
While there is a possibility that the current bout of taper talk would still hurt emerging markets, we think there are several factors that mitigate against severe capital flight. Unlike in 2013, the current tapering is not coming as a surprise. The Fed has been conscientizing the markets which allows investors to gradually adjust their positions on time.
Secondly, most emerging markets seem to have ample dollar reserves with their adequacy ratios mostly above the minimum 7% threshold as shown on the graph below. In 2013 things were different as most had adequacy ratios of less than 7%. Countries which had dollar reserve adequacy ratios of less than 7% fared badly than those which had a ratio of 7%.
That some emerging markets like Turkey and Brazil, have already begun to tighten interest rates will help defend the relative attractiveness of EM real interest rates versus developed markets where real interest rates are poised to remain negative for a long time regardless of the taper tantrum.
Given the above reasons, we do not see any reason to be bearish on SA bonds. Indeed, we expect near-term volatility around the Fed’s tapering but that does not throw away the investment case for SA bonds into the bin. Should the accommodative monetary policy stance continue, with no internal-own goals which hinder the debt consolidation efforts, will likely bode well for bonds.
Note: Reserve adequacy equals central bank foreign exchange reserves minus short-term foreign-currency denominated debt plus the current account divided by the gross domestic product (GDP)
Source: Federal Reserve of Dallas