1. USD denominated EM bonds do not have local currency risk. Dollar-denominated means that the EM bonds are issued in U.S. dollar terms, limiting currency risk for the investor. If we look at this sector compared to local currency bonds, we’re seeing that year-to-date performance is positive, thanks to falling U.S. Treasury rates.
2. Local EM bonds have local interest rate risk, along with currency risk. As the name suggests, local currency bonds are denominated in local currencies, such as Russia’s ruble and Ukraine’s hryvnia, and are affected by currency fluctuations. The ruble has declined nearly 10% this year, making it one of the weakest EM currencies YTD, and the hryvnia fell to a record low against the dollar at the end of February. These bonds are also impacted by movements in local EM interest rates. Depreciating currency valuations relative to the USD, coupled with a series of rate hikes in many EM countries, have taken a toll on local currency bonds.
The bottom line is that we expect to see continued volatility in EM bonds, but we believe that USD denominated bonds will hold up better in the current environment. Just remember that not all EM debt is the same, understanding the differences will help you choose the right investment.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog. You can find more of his posts here.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets, in concentrations of single countries or smaller capital markets. iS-12007