Singapore: Interested in emerging-market debt but wary about rising bond yields as the Federal Reserve keeps raising interest rates? Then it might be worth looking at what used to be a riskier option— local-currency bonds.
Historically low inflation rates in countries from Indonesia to Brazil mean, as a group, developing nations aren’t facing the pressure they sometimes had during US monetary tightening cycles. And with the US dollar depreciating even as the Fed hikes, local-currency debt has some insulation from worries such as supply hitting the Treasuries market.
“In a period of a weak dollar, EM local bonds will benefit from the improvement in the currency component,” said Manu George, Singapore-based senior investment director of Asian fixed income at Schroder Investment Management. “Returns from EM local bonds could outperform EM dollar bonds.”
Domestic notes sold by developing-nation governments have returned 1.9% so far this year, extending last year’s gain of more than 14%. Dollar securities from emerging markets, including corporate debt, are down 1.9% this year, according to a Bloomberg Barclays indexes.
The local debt could even be something of a refuge if trade tensions escalate, in the view of some. President Donald Trump’s protectionist moves have served in part to highlight the US trade deficit and the increasing borrowing needs of the world’s No. 1 economy, with the fiscal gap widening.
Without doubt
“I would take advantage of any weakness that generates to add to emerging-market FX risk,” said Edwin Gutierrez, London-based head of emerging-market sovereign debt at Aberdeen Standard Investments, referring to concerns of a potential trade war. He said he prefers “local currency without a doubt because of the weak dollar.”
His favourites are Brazilian, Indian and Russian local-currency debt, as their rates remain high relative to inflation.
The hard-currency notes from developing nations are likely to underperform because they remain “very correlated” to Treasuries, said Jean-Charles Sambor, the London-based head of emerging-market fixed income at BNP Paribas Asset Management.
Fed officials, in the first interest rate decision under chairman Jerome Powell, raised the benchmark lending rate a quarter-point on Wednesday and forecast a steeper path of hikes in 2019 and 2020, citing an improving economic outlook. The US Treasury’s yield curve from 2 to 10 years steepened Wednesday.
While the potential for “massive” reductions in premiums on local-currency debt is now gone, after the big run-up in the securities, BNP Paribas’s Sambor said there are “still pretty compelling stories” in markets including India, Indonesia, Brazil and Peru.
Meantime, don’t count dollar bonds out completely. George at Schroder said “a rise in yields will make good quality EM dollar bonds attractive and we are likely to add exposure if yields show signs of stabilization.” He prefers corporate bonds for the yield pick-up, with examples including Petroleos Mexicanos and Petroleo Brasileiro SA. Bloomberg