Emerging markets bonds and the corresponding ETFs have been among this year’s hottest asset classes.
However, in the wake of 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.
If the Federal Reserve hikes rates, emerging market companies that borrowed overseas are more susceptible to foreign capital swings and could find it more difficult to refinance debt. Moreover, a strengthening dollar makes it costlier to pay off dollar-denominated bonds.
With the specter of rising rates increasing, proper evaluation of emerging markets bond funds takes on heightened importance. That means avoiding the ETFs with heavy exposure to the largest countries with the biggest debt loads. The PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) can help investors skirt some of the pitfalls of investing in developing world bonds.
PCY tries to reflect the performance of the DB Emerging Market USD Liquid Balanced Index, which tracks U.S. dollar-denominated government bonds issued by 22 developing economies. While the ETF has been a stellar performer this year, some technical analysts are expressing near-term technical concerns.
“When we zoom out further and look at a weekly chart (see 2nd chart below), it looks like this ETF could decline to the 24-25 area. If/when we get there, things get really interesting,” according to See It Market. “Depending on your angle, one could put neckline support at 27 or 25. But, either way, I see a big old thump forming.”
Moreover, emerging market bonds are also being supported by the strength of local currencies against the U.S. dollar. Emerging market currencies have appreciated after the bouts of extensive weakness last year. However, that scenario is vulnerable as the U.S. dollar has been a tear recently against other currencies, developed and emerging.
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. Bonds issued by developing countries have arguably benefited from the aggressive central bank policies from developed economies that depressed global yields, the Financial Times reports.
For more information on the fixed-income market, visit our bond ETFs category.
PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY)
