Central bank tightening could boost this bond ETF

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Here in the United States, fixed income investors face roughly 2021 and reflect on the impact of an interest rate hike in 2022 by the Federal Reserve.

Some global central banks are already raising rates, but it’s not all bad news as some exchange-traded funds could benefit from this tightening. This group includes ETF VanEck JP Morgan EM Local Currency Bonds (NYSEArca: EMLC).

The $ 3.4 billion EMLC tracks the JP Morgan GBI-EM Global Core Index, which is a basket of local currency-denominated bonds of emerging market sovereign issuers. On the basis of higher interest rates that could push currencies higher, local currency bonds in developing economies could be supported by the new rate tightening regime.

“The market is currently anticipating further tightening in almost all non-Asian economies as central banks react quickly to surprises with rising inflation, as well as higher-than-expected growth and improving markets. work, ”he added. says Fran Rodilosso, VanEck responsible for the portfolio management of fixed income ETFs.

Over 20 emerging market currencies are represented in EMLC, of ​​which only five are Asian currencies. The fund’s third geographic weight is Brazil at 8.67%. Latin America’s largest economy recently inflated borrowing costs, and market watchers largely expect this trend to continue as the central bank seeks to avoid inflation.

One of the reasons the Fed is considering a rate hike in 2022 is inflation, and it’s one of the main reasons central banks in emerging markets are already raising borrowing costs.

“Emerging markets do not have the same ability to tolerate above-normal inflation and, over the past two decades, have been monitoring financial stability issues more closely, given their reliance on external funding. . Central bankers have remained vigilant in a context of high inflation, maintaining their credibility and their dependence on conventional monetary policies to control inflation expectations, ”adds Rodilosso.

EMLC, which brings in 5.20%, has an effective duration of 5.02 years, which places it in medium-term territory. The fund allocates around 26% of its weighting to Latin American economies, which are often sensitive to inflation and are home to central banks that have faced rising consumer prices in the past, which means that they are often quick to raise their rates when inflation rises. . In addition, there is an opportunity for a rate difference with EMLC.

“In addition, the rate differential between local currency bonds in emerging countries and US interest rates, which was almost at the lowest level for a decade before the pandemic, has increased considerably this year,” Rodilosso concludes. “In nominal terms, the yield spread has grown to around 4.1 percentage points, from 3.6 at the start of the year and 3.4 at the start of 2020. This increased cushion provided by interest rates the market can also help support currencies, in our view. “

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The opinions and forecasts expressed herein are solely those of Tom Lydon and may not come to fruition. The information on this site should not be used or interpreted as an offer to sell, a solicitation of an offer to buy or a recommendation for any product.


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