If bond markets can forecast gains for equities, then the news should be good for emerging markets stocks and exchange traded funds (ETFs) because the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) is on fire.
As a dollar-denominated emerging markets debt fund, PCY and rival such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and the Vanguard Emerging Markets Government Bond ETF (NasdaqGM: VWOB) are benefiting from the Federal Reserve’s dithering on interest rates and the weaker U.S. dollar.
Previous Fed rate hikes have triggered volatility in the emerging markets. While many emerging markets have garnered a bad reputation for experiencing spiraling debt defaults in face of rapid currency depreciation, the developing economies are more resilient in a weak commodities environment.
According to BlackRock, emerging market governments have accumulated less dollar debt, built up foreign reserves and adopted flexible exchange rates to obviate mistakes during the 1980s and 1990s crises. Though the current outlook for emerging markets debt is far from sanguine, some analysts see opportunity in the asset class.
The attractive emerging market bond yields, though, are not without their risks. For example, many fixed-income observers are closely watching the Federal Reserve’s monetary policy. A Fed rate hike could cause a large exit out of emerging market assets in favor of better returns in the U.S.
However, it should be noted that most of the bonds held by EMB and PCY, the two largest emerging markets bond ETFs, are rated well into investment-grade territory.[related_stories]