Venezuela, Mexico, Russia bonds seen gaining in 2013

December 11, 2012, 2:41 PM

marketwatch.com

Emerging market bonds are expected to post returns close to 8% in 2012, mostly from currency appreciation, Morgan Stanley analysts said.

While Mexico, Russia and India top their list of recommendations, for those looking for riskier plays, they see gains in peripheral European sovereign debt in the first half of the year, as well as Venezuelan bonds.

“Weaker developed-market growth suggests more liquidity provisions and monetary policy accommodation, or anticipation of it, which will drive ongoing migration to higher-yielding emerging-market assets,” said Rashique Rahaman, global co-head of emerging market currency strategy.

Investors must be more selective, as some emerging-market countries face big macroeconomic challenges, or simply manage policy and their currency more heavy-handedly.

The currencies of Mexico USDMXN -0.40%, Russia  USDRUB -0.25% and India USDINR -0.17% are seen rising as the countries move forward with more structural reform efforts. Dollar-denominated bonds, which remove that currency reward, may show “barely positive returns,” he said.

Bigger, long-term investors that are traditionally conservative-minded, like sovereign wealth funds and pension funds, have also shifted some assets into emerging markets, which provides underlying support for them.

Still, corporate debt in emerging markets is even dicier, but some Venezuelan names, or in general oil, gas and telecom companies can offer value, he said on a conference call Tuesday.

Emerging-market debt returns will easily top gains in U.S. corporate debt, while both ends of the U.S. credit spectrum — safe-haven Treasury debt and risky high-yield bonds — are seen as performing worse than this year.

Among more developed-market currencies, head of FX strategy Gabriel De Kock added that the firm sees the dollar  USDJPY +0.16% rising to 92 Japanese yen, from around 82 yen now, which would be its highest since mid-2010.

European peripheral bonds are expected to improve in the first half of the year after Spain asks for international aid — something its leaders have been very reticent to do. That will bring the European Central Bank into its debt market and reduce the extra yield it has to pay over German bunds, the European benchmark. That will bring in capital from outside the euro zone, boosting other debt markets. However, by the second half of the year, the European Central Bank will be forced to lower interest rates, pushing the euro  EURUSD +0.48% down to end the year around $1.20, from about $1.31 currently.

The Australian currency is also in for a decline, as falling commodity prices, and in particular the increasing supply of iron ore, will further weaken its trade position and push the Reserve Bank of Australia to cut rates. The Australian dollar AUDUSD +0.27%will fall to buy about 90 U.S. cents, from $1.0527 currently.

– Deborah Levine