As capital flows head towards Asia and emerging markets, global investors are increasingly keen on local-currency debt. This will drive emerging markets to introduce inflation-linked bonds within three-to-five years, particularly from Asia, predicts Paris-based Pascale Blanque at Amundi.
Blanque has a dual role as both Amundi’s CIO and its deputy CEO responsible for sales globally to institutional investors and wholesalers.
“If there is one global inflation risk remaining, it is in Asia,” he says. “There are many institutional investors in the region that have no means of matching their liabilities. Right now they are allocating to real assets such as commodities. They need ‘linkers’. But this is a medium-term view.”
He adds that along with internal demand, governments will find a growing appetite among global investors for such instruments.
Moreover, if emerging markets are to achieve what he terms ‘financial autonomy’ they need to put their own savings to work in their domestic capital markets. Until these develop further, Western investors will drive liquidity, leaving emerging markets vulnerable to sudden outflows.
Blanque says the inflation of asset prices in emerging markets, particularly in Asia, is a likely outcome of the US Federal Reserve System’s latest $600 billion bond-buying exercise.
Although global capital is increasingly shifting towards higher-growth, sounder emerging markets, the biggest flows have been to equities. But Blanque says the big story in the coming years will be flows to local-currency debt, particularly among the Bric quartet.
“Emerging-market debt is generally not very expensive,” he says. “For many countries, spreads are not that tight. Equity valuations are fair, and if they are to rise further, one needs to argue they are priced at a discount to Western markets. It’s easier for debt spreads to tighten than for equity valuations to rise.”
He also likes debt as a means of getting exposure to undervalued currencies.
Although he, like many global CIOs, favours a greater allocation to emerging markets, and expresses doubts that the Fed’s quantitative easing will have the desired effect, he does not adhere to the notion of EM ‘decoupling’.
If anything, he believes that success in emerging markets will be partly determined by how well the US economy recovers.
“The worst case scenario is that QE2 has no impact and leads the US into Japan-style deflation,” Blanque says. “But the US is not Japan. To like emerging markets, you must be positive on prospects for the West. The notion of decoupling is not the reality; the Asian economic model is still driven by exports, despite the rise of internal demand.
"If the US enters a liquidity trap, this will have consequences for Asian markets. Today the buyers of last resort for emerging market assets are still found in the West. So when you invest in emerging markets, you have to keep an eye on what happens in the US.”