Emerging Market Bonds Are Catching Wall Street’s Eye. What the Attraction Is.
Emerging market bonds have sold off over the past two weeks, ever since Federal Reserve Chairman Jerome Powell signaled a hawkish shift on U.S. interest rates.
But the average spread for emerging market hard currency sovereign paper over U.S. Treasuries remains near its postpandemic low, around 3.4 percentage points, says Sergey Goncharov, head of Americas fixed income at Vontobel Asset Management. That’s down from 460 basis points five months ago—a powerful rally in fixed-income terms. (A basis point is 1/100th of a percentage point.)
There are two ways to look at this steady performance: Emerging market bonds remain fully priced and vulnerable to further global shocks, or emerging market economies are stable by historical standards, and that 340 extra basis points of yield is worth the risk. “The market is divided between spread sellers and yield buyers,” says Edward Al-Hussainy, senior currency analyst at Columbia Threadneedle Investments.
Pros in the space are splitting the difference by shifting toward solid credits from the likes of Mexico, Indonesia, and Saudi Arabia, away from higher-yielding names. “We are not chasing risk in our portfolios,” says Samy Muaddi, portfolio manager for emerging market bonds at T. Rowe Price.
Expectations that the Fed will stay higher for longer have undercut one driver for emerging market bonds: anticipation of interest-rate cuts in countries that tightened faster and more aggressively than the U.S. in 2022-23. These bets focused on Brazil, Mexico, and other Latin American sovereigns.
“We have parted ways with the LatAm rate cutters after a massive run in the bonds,” says Michael Kelly, head of PineBridge Investments’ multi-asset strategy.
Another driver was policy reform in countries that were either in or threatened with credit default, from Argentina and Nigeria to Egypt and Turkey. This year’s unlikely fixed-income stars are Argentina and Ecuador, where new presidents promising fiscal stringency have returned up to 80% for bondholders, Goncharov says.
Further gains look tougher to come by. “Nothing is dirt cheap anymore,” he says. “High-yield spreads have tightened from 1,000 to 600 basis points.”
Emerging markets, with their enormous diversity, remain fertile ground for bond pickers. Another 2024 macro story—rising commodity prices—is creating value in the debt of oil exporters like Colombia and Nigeria, says Eric Fine, head of emerging markets active debt at VanEck. Nigerian dollar bonds maturing in 2028 are yielding around 9% annually. Three-year paper from Mexican state oil producer Pemex pays 9.5%.
PineBridge’s Kelly sees bargains in Asian high-yield corporate debt. The travails of Chinese property developers are obscuring value elsewhere, he argues. For instance, Indian utilities, which are borrowing heavily to power the new great growth economy.
“You’re getting high-single/low-double digit yields on credits,” he says. Kelly also likes debt from casinos in China’s Macau, whose postpandemic recovery is gathering momentum.
One national restructuring story that may still have legs is Pakistan, Vontobel’s Goncharov adds. The International Monetary Fund OK’d a $1.1 billion aid tranche for the country last month, citing “prudent policy management and resumption of inflows.” Eurobonds maturing in 2027 yield north of 11%.
Clearly, these perceived bargains fall into the idiosyncratic category. The big story on emerging markets is that they aren’t the big story anymore as sources of world financial risk. The IMF recently named four countries that “critically need to take policy action to address imbalances”—the U.S., China, the United Kingdom, and Italy.
If those supertankers flounder, no one will escape the waves, though.