Traders Trapped in Frontier Bonds Ramp Up Currency Shorts

LAGOS (Capital Markets in Africa) — Investors trapped in some of the world’s most illiquid bond markets are rushing to short local currencies, driving up the price of hedging their positions.

The implied yield on three-month non-deliverable forward contracts — or the cost of borrowing the local currency now in order to sell it in the future — has jumped threefold for Ukraine’s hryvnia this month, more than doubled for the Nigerian naira since mid-February, and climbed almost 50% for the Egyptian pound since January.

While traders often buy currency forwards to mitigate the risk of holding local debt, the latest surge in demand shows the extent to which emerging-market investors are scrambling to limit the fallout of a bond rout. Last week, they withdrew a record $5.7 billion from debt funds as the impact of the coronavirus worsened.

The speed of the exodus has been particularly brutal for foreign traders who piled into high-yielding frontier markets over the past year, and where there are not enough local buyers to sell bonds back to.

In Ukraine’s local bond market, foreign investors “cannot sell the bonds, it’s not possible. So they sell the currency,” Viktor Szabo, a money manager at Aberdeen Asset Management in London, said by phone. “If you want to hedge risk, you have no other choice.”

In Egypt, the market dislocation is so sharp that the spike in non-deliverable forwards makes “hedged yields on Egypt local market exposure negative,” Morgan Stanley strategists including Jaiparan S Khurana wrote in a report last week, recommending buying Egypt’s Eurobonds instead.

The implied yield on three-month non-deliverable forward contracts for Ukraine’s hryvnia spiked to a high of 43% last week from 9.1% at the end of last month. The same measure for the Egyptian pound has risen to 18.3% from 12.5% at the end of January. And for the Nigerian naira, it’s climbed to 34% from less than 9% in mid-February.

Source: Bloomberg Busines News