The strengthening U.S. dollar could cause grief for the emerging markets and potentially increase default risks for USD-denominated emerging market corporate bond exchange traded funds.
Some investors have turned to U.S. dollar-denominated emerging market bond ETFs for the attractive yield opportunities. For instance, the actively managed WisdomTree Emerging Markets Corporate Bond Fund (NasdaqGS: EMCB), the largest ETF that tracks developing world corporate debt, has a 5.34% 30-day SEC yield. The SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (NYSEArca: EMCD) comes with a 4.51% 30-day SEC yield. Lastly, the iShares Emerging Markets Corporate Bond ETF (NYSEArca: CEMB) has a 4.54% 30-day SEC yield.
However, investors may face greater credit risk with a stronger U.S. dollar. [Overseas Capital Flight Could Mantain Dollar ETF Strength]
“Should the US dollar, the dominant international currency, continue its ascent, this could expose currency and funding mismatches by raising debt burdens,” Claudio Borio, the head of the Bank for International Settlements’ monetary and economic department, said in a quarterly review.
A strong dollar would make debt obligations harder to repay – emerging market companies would have to repay loans in USD terms, exchanging more of their weaker local currency for the stronger greenback.
Borio also pointed to a similar situation in the 1980s and the 1990s where a stronger dollar triggered problems in the emerging markets. While many emerging market governments have learned their lesson from the earlier Latin America and Asia crisis, many companies in developing economies have still been heavily borrowing through dollar-denominated issuance, Financial Times reports.
The BIS has issued a warning about the imbalance between dollar debt and dollar output. For instance, emerging market borrowers have issued $2.6 trillion of international debt securities, with three-quarters denominated in dollars. Additionally, international banks’ cross-border loans to emerging economies was $3.1 trillion by mid-2014.