EM Fixed Income:What the betas to core rates are telling us

Betas for 10Y EM bonds to US-treasuries experienced a sharp increasepost the US-election outcome in Nov-16. By looking into the 90d rollingbetas for the regions - EMEA, LatAm and Asia - we see record high levelsin Q4-16, followed by a sharp decline in the following months, as latebetas are slowly grinding higher again across all three regions.

    Betas to US rates are significantly higher during bearish periods. Inparticular, high-yielders (South Africa, Mexico, Turkey, Brazil) are moresensitive to sell-offs in US treasuries. Although the DB US-Strategy teamdoes not expect a sudden spike in US treasuries, the house view for 10Ytreasuries with 2.50% by end-Q3 and 2.75% by end-Q4 is well above theforwards. This increases the risk for EM local bond markets tounderperform in particular for those countries with historically highsensitivity to US rates and/or current short-term betas well belowLT average betas.

    In this chart pack update, we evaluate sensitivity of selective EM countriesto US-treasuries. First, we highlight countries providing high/low betas toUS rates. In addition, we analyze in which countries the current beta isalready well above (below) the LT average, providing better (worse)protection against any US-repricing. Why? We found that 90d betas +/-1stdev below/above the LT average (4.5 years) tend to sharply overshoot inthe other direction over subsequent months. Hence, we argue that short-term betas vs. long-term betas matter in particular when they reachextreme levels.

    Countries with the highest/lowest long-term betas: Historically, Mexico,Brazil, Israel and Poland provide the highest betas to US rates. On theother hand, betas are low in India, Malaysia and Romania.

    Current betas relative to long-term betas: Although betas are noticeablylower in Asian countries, they are currently significantly closer to theirpeak (87-percentile) than in EMEA (67-percentile) or LatAm (62-percentile).

    Based on our "Sensitivity monitor" - combining the LT betas (the higher theworse) and the current beta relative to LT betas (the lower the worse) -Romania, India and Malaysia would currently be the most resilient fixedincome markets, while Brazil, Mexico and South Africa are the threecountries that are most exposed to a sharp increase in US treasuries.

    South Africa: The beta in South African 10Y bonds vs. core rates sharplydeclined in recent months and moved -1 stdev below the long-termaverage. Despite some recovery as of late, we expect any sell-off in core-rates to lead to noticeable underperformance in South African bondscompared to peers.

    Chile: Although the long-term beta for local bonds in Chile to US treasuries is not necessarily high compared to peers, it most recently reached the highest level in history (+1 stdev above LT-average). We expect a decline in betas over the next few weeks suggesting lower exposure to US-treasuries in the eventuality of a bearish move in core-rates.