Emerging Market Bonds Are Rallying. Where to Invest.
Bond markets everywhere are hot, anticipating interest rate cuts from the Federal Reserve and other central banks. Emerging market bonds are on fire.
The iShares J.P. Morgan USD Emerging Markets Bond exchange-traded fund has climbed 11% over the past two months. Spreads, the average premium in emerging market yields compared with U.S. Treasuries, have compressed by 150 basis points, says Samy Muaddi, portfolio manager for emerging market bonds at T. Rowe Price.
Investors can still profit going forward, if they look past the low-hanging fruit of dollar bonds from investment-grade sovereign borrowers. “Hard currency is looking picked over except for some distressed names,” Muaddi says.
He is focusing instead on local-currency bonds, particularly from the Latin American giants Brazil and Mexico. Both enacted epic rate increases to fight inflation—Brazil hiking from 2% to 11.25%, Mexico from 4% to 11.25%. With inflation in retreat, central banks can loosen again, music to bondholders’ ears.
Muaddi sees another lucrative story in Indonesia, which raised rates from 3.5% to 6%, and has wrestled inflation below 3%.
These markets have already rallied. Investors are pricing in 280 basis points of easing by Brazil, 180 basis points for Mexico, says Edward Al-Hussainy, senior currency analyst at Columbia Threadneedle Investments.
He is a buyer anyway. “My bet is there’s more room for these guys to cut,” he says. “Local currency bonds look much more attractive going into next year.”
Alejandro Arevalo, head of emerging markets debt at Jupiter Asset Management, sees opportunity in emerging market corporates, which actually have twice as much hard-currency debt outstanding as governments, around $3 trillion. The biggest issuers are quasi-sovereign oil or natural resource companies, which can keep pumping profits, and paying off bonds, even if their host country wobbles.
Examples include YPF of Argentina, whose paper yields close to 12% annually, and Colombia’s Ecopetrol, which is paying 7.3%. “You can find good corporate stories even where you don’t like the macro,” Arevalo says.
Then there are those distressed hard-currency sovereign credits. Presidential elections this year brought rays of hope to at least three perennial hard credit cases, Nigeria, Ecuador, and Argentina, says Sergey Goncharov, head of fixed income Americas at Vontobel Asset Management. Bonds from all of them yield well into double digits, so any positive shift in sentiment could prove highly profitable.
He is particularly focused on Nigeria, where President Bola Tinubu has slashed budget-crippling fuel subsidies and axed distorting dual exchange rates since taking office in May. “You’ve got an agile reformist president and an oil story,” Goncharov says.
T. Rowe’s Muaddi adds three other high-yielding African countries to his watch list: Angola, Kenya, and Egypt. Turkey’s dollar debt has moved out of distressed territory since a new central banker started pushing interest rates to 40% to quell inflation. Yields are near 7%, compared with 11% a year ago, Al-Hussainy reports.
Emerging market debt will always be heavily affected by circumstances beyond its control, specifically those made in Washington. “Central bankers have to perform a two-step dance,” Al-Hussainy says. “If they get too far ahead of the Fed on rate-cutting, their currencies will suffer.”
For now, tailwinds look stronger than headwinds. Lower global rates should spur a spate of new issuance in 2024, which could start to lure back capital that has been fleeing emerging market bonds since the pandemic. “This is an under-owned asset class that is still attractive,” Al-Hussainy says.