After a disastrous 2022 as the Federal Reserve (Fed) tightened monetary policy, emerging market sovereign debt, including local currency bonds, is making a comeback in 2023.
This is true across many areas of the fixed income space, but local currency bonds issued by developing country governments have gained momentum this year.Consider the case of VanEck JP Morgan EM Local Currency Bond ETF (EMLC). As of Sept. 1, the exchange-traded fund is up 7.1% year-to-date, beating the Bloomberg Composite U.S. Bond Index by more than 6-to-1.
The EMLC, which tracks the JP Morgan GBI-EM Global Core Index, has delivered its impressive performance, benefiting from an attractive 30-day SEC yield of 6.74%, with fixed income investors It also supports that you can eat cake in terms of. Yield by EMLC.
EM bond fundamentals have solid fundamentals
In terms of equities, the emerging markets ex-China have performed exceptionally well this year. In that regard, EMLC’s performance in 2023 will be all the more impressive considering that the ETF allocates 10.60% of its weight to renminbi-denominated bonds. The asset class faces headwinds in 2023.
EMLC’s solidity speaks to the advantages of geographic diversification and sound bond fundamentals in other developing countries.As Jean-Charles SamborBNP Paribas head of emerging markets fixed income said inflation was trending lower in many emerging markets. This confirms that the aggressive measures taken by these countries’ central banks in 2021 have paid off.
In addition, emerging market fiscal and international balances are increasing as many developing countries build up their foreign exchange reserves, Sambar said. Declining fiscal deficits in some emerging economies further underscore EMLC’s strong fundamentals.
It remains to be seen if the rating agencies will be enough to raise the credit ratings of EMLC member countries, but this factor is undoubtedly positive. Currently, approximately 71% of EMLC’s holdings are rated investment grade, with nearly one-third of those rated AAA, AA, or A. This is a result of limited fiscal stimulus in emerging economies compared to advanced economies. Other factors may also bode well for EMLC.
“For hard currency bonds, spreads to U.S. Treasurys are likely to tighten, leaving emerging market high-yield bonds, in particular, with room for significant returns. Given the possibility of lowering the policy rate next year, local currency debt is at a tipping point with the prospect of reversing last year’s US dollar-related decline.
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