Bond vigilantes are calling the shots in emerging markets now

By Ezra Fieser, Selcuk Gokoluk & Maria Elena Vizcaino

IT didn’t take Nigerian President Bola Tinubu long to comprehend his situation. With the country’s stash of hard currency dwindling, investors, not policy makers, were in command. So, on his second week in office, he gave them what they wanted, sacking the central bank chief and devaluing the currency.

Days earlier, Recep Tayyip Erdogan, the long-standing leader of Turkey, had reluctantly come to the same conclusion. Out went the architects of the economy’s byzantine web of rules and restrictions and in came the Wall Street pros to simplify policy to woo back disgruntled investors. Stocks and bonds surged.

Such is the new dynamic of power in a world of rapidly rising interest rates. Investors are demanding economic orthodoxy and, for the first time in almost two decades, are in a position to make sure their voices are heard. Across the developing world—in Colombia, Egypt and, to a certain degree, even in Argentina, a perennial market pariah—governments are pivoting away from heterodox policies. When interest rates in G-7 countries were hovering near zero and cash was flowing freely around the globe, there was little angst in policy circles about alienating investors.

But when those investors can suddenly rake in 5 percent or more— stress-free—by parking their cash in US T-bills or blue-chip corporate bonds, policy makers have to work a lot harder to entice them into providing the financing needed to pay teachers, build highways and power economic growth. That means either dangling astronomically high yields—an unsustainable approach over time—or committing to the sorts of basic policies long favored by the Davos crowd: fiscal austerity, limited government intervention in the economy and simple rules for moving money in and out of the country.

“You have this battle between placating your common person as well as the people that voted for you with maintaining external investors, who obviously help your balance of payments and reserves,” said Mark Hughes, who manages a portion of the $400 billion in assets at Western Asset Management. “Ultimately, when we see politicians or policy makers make difficult decisions, for us that’s a good thing.”

The reform stories are proving to be some of the biggest surprises in a year in which emerging markets have failed to live up to investors’ optimism, as China’s reopening fizzled and central bankers kept raising interest rates.

On average, sovereign bonds from five countries—Argentina, Colombia, Egypt, Nigeria and Turkey—handed investors a return of 6 percent since the start of June, compared to a 1.8 percent return across government debt from developing nations, according to a Bloomberg index.

The shifts are the latest in a long-standing tug-of-war between government officials and bond vigilantes, as economist Ed Yardeni famously called investors in the 1980s for their ability to mete out punishment when they disapproved of policy decisions.

Their influence waned greatly this century, drowned out by quantitative easing across the developed world, but the key role that the bond market played in taking down the Liz Truss government after just 44 days signaled the balance of power was shifting once again. The UK, of course, isn’t a developing nation— despite the mocking jabs of its harshest critics— and yet, the message was crystal-clear: This is a dangerous time for fiscal experimentation or any policy that is unconventional in nature. High borrowing costs are forcing corporate CFOs and finance ministers alike to play by the market’s rules

See “Bond,” A15