Despite recent headwinds from a strong U.S. dollar, EM local currency bonds present a compelling investment opportunity due to favorable fundamentals, easing U.S. monetary policy, and new Chinese stimulus measures.
For much of the past four years, including most of this year, the strength of the U.S. dollar has been a headwind for emerging markets (EM) assets, including local currency sovereign bonds. Although the asset class has outperformed broad U.S. and global investment grade bonds, investor sentiment has been weak based on investment flows. This is despite very favorable fundamentals relative to developed markets. With favorable growth and fiscal trends, controlled inflation and high levels of real interest rates, all on top of a significantly lower gross debt-to-GDP ratio, the case for EM local currency bonds has been strong, in our opinion. The change in the rate cycle in the U.S. and the magnitude of new Chinese stimulus measures further strengthen the case, and we believe it’s time for investors to consider an allocation to EM local currency bonds within their global bond portfolio.
Easing monetary policy in the U.S. removes a headwind that has been in place since the Fed began hiking aggressively in 2022. A soft landing in the U.S., which remains a likely scenario over the next six to twelve months, provides a “goldilocks” scenario of lower rates and support for economic growth. In China, new fiscal and monetary stimulus along with new measures to stimulate the domestic property market were announced. The dynamics taking place in the world’s two largest economies are positive for global growth, and many of those benefits will accrue to emerging markets. For example, commodity sensitive currencies will likely benefit from higher growth. In that category, Latin American currencies have been the worst performers in the J.P. Morgan GBI-EM Global Core Index this year, providing upside potential in our opinion, particularly given that the new measures in China took the market by surprise. Latin America accounts for more than 25% of the index.
EMFX Year-to-date Performance (as of 9/30/2024)
Longer term, we expect emerging markets to continue to compare favorably overall to the U.S. and other developed markets from a fundamental perspective. U.S. government spending and borrowing trends are highly unfavorable for the U.S. dollar, in our opinion, and there is little reason to expect any changes in the current trajectory. The continued monetary and fiscal stimulus also suggests that there could be higher inflation than we had seen the decade prior to the Covid-driven shock, and that may benefit commodity producers.
EM local currency sovereign bonds are generally considered a “risk-on” asset class, despite these favorable fundamentals, which exposes the asset class to certain technical risks in the near term. Geopolitical instability, the upcoming U.S. elections and a harder landing in the U.S. than currently anticipated are the most obvious risks. However, we believe the long-term fundamentals make the asset class attractive, particularly as we move into a period of Fed easing, stimulus measures being implemented globally and a weaker or stabilized U.S. dollar.
For more news, information, and strategy, visit the Beyond Basic Beta Channel.
By Fran Rodilosso and William Sokol
Originally published on Oct. 22, 2024.
DISCLOSURES
Please note that VanEck may offer investments products that invest in the asset class(es) or industries included in this blog.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.
The J.P. Morgan GBI-EM Global Core tracks local currency bonds issued by emerging markets governments.
Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging markets bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Associates Corporation.
© 2024 Van Eck Associates Corporation.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent white papers.
© VanEck
More Asset Allocation Topics >
