Ecentral banks in melting markets are beating their counterparts in developed markets by raising interest rates, and while this can be a drag for investors considering debt in developing markets, it is not necessary .
In fact, hawkish emerging market central banks could be catalysts for exchange-traded funds, including the ETF VanEck JP Morgan EM Local Currency Bonds (NYSEArca: EMLC). While rate hikes in all jurisdictions are widely seen as a drag on obligations, especially longer-term rates, the recent round of tightening could be in EMLC’s favor.
The VanEck ETF seeks to track the JP Morgan GBI-EM Global Core Index, which includes bonds denominated in local currencies. With the dollar strong this year, many emerging market currencies are taking a hit, but rate hikes could support those currencies.
However, there are other benefits to emerging market rate hikes, and those benefits could benefit EMLC investors over time.
âRate hikes accelerated as inflation accelerated and the US dollar strengthened. A wide variety of countries are now tightening their policies, ranging from Brazil to Russia and South Korea â, according to BlackRock research. “The result? The emerging world has a head start in normalizing policy. The weighted average emerging market policy rates now stand at 3.2%, compared to near zero or negative rates in the United States. United and in the euro zone. “
Brazil and Russia accumulate more than 13% of the geographical exposure of EMLC, according to VanEck data. Beyond that, there are benefits to emerging market central banks beating their developed market counterparts when tightening rates.
âThe bull cycle started long before the Fed tightened – which has often caused problems for emerging markets as investors begin to demand more compensation for holding riskier assets,â adds BlackRock. “The Fed has just started cutting back on asset purchases and we don’t see it hike rates until mid-2022. The EM approach has created a large interest rate cushion against the DM, lowering valuations and increased coupon income. “
In this climate, revenue is essential, and EMLC achieves it, as highlighted by a 30-day SEC yield of 5.38%. Obviously, there will always be more risk with emerging market bonds than with US Treasuries, but just over 21% of EMLC’s holdings are non-investment grade. In addition, the outlook for emerging debt to 2022 is attractive.
âImproving valuations and coupon income should help cushion any rise in yields and prevent disorderly moves in emerging market bonds when the Fed takes off, we think. Indeed, we don’t see a repeat of the taper tantrum of 2013 when the Fed’s decision to cut asset purchases wreaked havoc on emerging market assets, âconcludes BlackRock.
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