Emerging Markets Offer Litmus Test for Traders’ Bold Rate Bets

When it comes to betting on higher borrowing costs in the developing world, some investors may be getting ahead of themselves.

In markets from South Africa to Mexico and South Korea, traders are penciling in a faster pace of interest-rate hikes than what economists say is currently warranted based on the inflation outlook.

“Almost all of them are overpricing tightening,” said Shamaila Khan, the head of emerging-market debt at AllianceBernstein in New York, whose $4.7 billion high-yield bond fund has topped 86% of peers in the past year.

The positioning reflects a common motif in markets: After months of Covid-19 lockdowns there’s a risk that policy makers run their economies hot, only to backtrack with sharper-than-expected rate hikes down the line.

HSBC Holdings Plc says the prospect that central bank support gets scaled back later than what current market pricing implies suggest there’s value in the front-end of the rates curve, including in South Korea and Poland.

Inflation data from South Korea to Turkey and Poland this week may offer clues on the path for monetary policy. In Mexico, traders will monitor the central bank’s quarterly inflation report on Wednesday for signs that the monetary authority could adopt a less dovish outlook.

“Unless near-term data releases provide a confirmation to what is being priced, the current market pricing is vulnerable to a correction,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore.

“The market is already pricing in more hikes than what fundamentals are suggesting,” she said.

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