Low interest rates and dollar weakness seen earlier this year combined to make for a perfect storm for emerging markets and the relevant exchange traded funds, including dollar-denominated funds such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) to local currency fare such as the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC).
Following Donald Trump’s stunning election victory and concerns that the Federal Reserve is nearing its first interest rate hike of 2016, some market observers believe emerging markets debt could be poised to retreat. The dollar’s recent strength could make emerging markets bond ETFs vulnerable.
Some market observers are concerned the emerging markets bond trade is becoming a crowded trade. While yields in developed economies remain depressed, with some even trading with negative yields, emerging market bonds have quickly gained traction as one of the few areas left with attractive yields. With the dollar surging, those concerns are heightened.
Rising inflation in the U.S. is also seen as a headwind for emerging markets debt.
“That’s because investors will migrate back to higher-rated bonds in developed economies instead of those in less-proven nations,” according to Bloomberg.
Emerging market bonds are being supported by the ongoing low-yield environment. According to the S&P Investment Policy Committee, the latest growth and inflation forecasts out of the Federal Reserve was not any different from figures reported back in June, which suggested that interest rates may remain lower for longer, with the yield on 10-year Treasuries still hovering around historically low levels.
With interested rates expect to remain lower in the developed world and perhaps decline further, some strategists see emerging markets sovereign debt as a prime destination of income-starved investors.
EMB tracks the J.P. Morgan EMBI Global Core Index, a market-cap-weighted index. Potential investors should note that since it is a cap-weighted index, countries with greater debt will have a larger position in the portfolio. EMB is now the largest emerging markets debt fund in the world, ETF or otherwise.
“More U.S. growth typically means a stronger dollar, which is a significant problem for emerging-market nonbank borrowers, which have accumulated more than $3 trillion in dollar-denominated debt, according to Bank for International Settlements data. The higher the dollar rises, the more expensive it becomes to pay back the debt,” reports Bloomberg.
For more information on the fixed-income market, visit our bond ETFs category.
iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB)
Tom Lydon’s clients own shares of EMB.