LONDON, July 27 (Reuters) - South Africa and Russia local currency government bond markets are undervalued as a rally in U.S. Treasuries and idiosyncratic issues in those emerging markets creates cheap pricing, a Morgan Stanley emerging market and FX strategist said on Tuesday.
"We're actually starting to see some decent value emerging in some EM bond markets," James Lord, Morgan Stanley's global head of FXEM strategy, told Reuters.
"Because of a rally of U.S. Treasuries, the yield differential now between U.S. assets some EMs looks attractive - Russia is one and South Africa is even more extreme as a result of a recent sell-off that was driven by the protests."
Real, or inflation-adjusted, bond yields in the U.S. have fallen in recent sessions in tandem with those in other major economies, a move analysts attribute to growing concern about the economic outlook following an upsurge in COVID-19 variants, as well as technical factors such as hefty bond-buying by central banks.
Morgan Stanley has turned bullish on South Africa's 2041 local currency bond after a recent sell-off in the wake of this month's protests and the bank's belief that the country's fiscal deficit for the 2021 to 2022 financial year would be around 8% of GDP, better than expected by many, said Lord.
"Those better fiscal numbers should lead to lower bond supply, lower risk premiums at the long-end, lead to flatter curves and on the back of the valuation improvement that we saw in the last few weeks," he said.
In Russia, an expected 50-basis-point central bank rate rise in September will likely bring an end to the recent hiking cycle, making the long end of the bond market look attractive and triggering inflows, while being supportive for the rouble , he said.
Morgan Stanley was bearish on the South African rand and a bunch of currencies in South America and parts of Asia as it bets on an upward path of the dollar through to the end of the year.
The U.S. Federal Reserve begins a two-day monetary policy meeting on Tuesday, a meeting which together with the Jackson Hole gathering of central bankers in August should give markets an idea about the Fed's positioning on the tapering of its policy, said Lord. (Reporting by Tom Arnold, Karin Strohecker and Marc Jones; Editing by Rodrigo Campos and Nick Macfie)