If the Federal Reserve maintains a slow and gradual interest rate hike schedule, fixed-income investors may turn to emerging market bond exchange traded funds to capture higher yields.
“We believe emerging market (EM) assets, particularly currencies and select sovereign bonds, may provide the best investment opportunities in the current low-yield environment – a condition that should persist into 2016, irrespective of any rate normalization policies from the Federal Reserve (Fed) or Bank of England,” Brandywine Global said in a Legg Mason research note.
Brandywine Global argues that accommodative policies and central bank activism will continue to support emerging market debt. Moreover, as the European Central Bank engages in loose monetary policies, the increased liquidity out of the Eurozone could also find its way into higher-yielding emerging markets.
However, Brandywine Global warned that the strong U.S. dollar remains a major headwind for the developing economies.
“A major aspect of our outlook relies on weakening G3 currencies — namely the U.S. dollar. Therefore, continued dollar strength remains a key risk. A strong dollar would continue to distort crude oil prices — and commodity prices generally — and ultimately detract from EM growth. Furthermore, the dollar could potentially rally, drawing liquidity away from EM assets,” Brandywine Global added.