In a ‘radical shift’, frontier markets go for policy changes

Frontier markets have embarked on aggressive policy shifts, and investors in local-currency bonds are starting to reap the benefits.

Central banks across key frontier economies including Kenya, Nigeria and Egypt have hiked policy rates significantly in recent months, while also implementing steps to liberalise markets – such as Nigeria’s move to allow free trading in the naira.

Those measures, aimed at curbing the tide of inflation brought about in part by depreciating currencies, signal a growing commitment to financial orthodoxy and stability. Some money managers are already positioning their portfolios to take advantage of falling yields and strengthening currencies that may be the result.

“Frontier in recent years has offered the horrible combination of negative real rates and overvalued currencies,” said Charlie Robertson, head of macro strategy at FIM Partners. “Now we have cheap currencies and in some cases, the highest real interest rates in the world. It’s been a radical shift.”

Demand for local-currency bonds in Kenya and Egypt has surged since the nations increased benchmark interest rates, Robertson said. Nigeria may see similar interest once its central bank completes its rate hike cycle, he said.

Ex-ante real rates in frontier markets – the difference between the nominal yields and the expected inflation rate – have moved further into positive territory, according to calculations by Goldman Sachs Group. That should give those markets a growing yield advantage as major developed markets move to reduce rates.”There are definitely opportunities in frontier markets,” said Peter Marber, chief investment officer for emerging markets at Aperture Investors based in New York. Currency devaluations and high yields in countries like Egypt, Nigeria, Argentina, and Turkey – which to some investors displays frontier characteristics – make those local bond markets attractive, he said.In addition, some low-rated sovereigns offer US dollar spreads of as much as 1,000 basis points, which have room for compression as US interest rates begin to fall this year, Marber said.

Bets on frontier markets can be tricky considering a record of policy u-turns from Nigeria to Zimbabwe.