The U.S. Dollar Index (DXY) has been retreating as of late on the notion that interest rate cuts will happen in 2024, paving the way for an emerging markets bond rally in the new year.
While capital markets are mainly laser-focused on the Federal Reserve and the moves they’re making to tamp down inflation, EM central banks have essentially been ahead of the curve. The foresight to raise rates and subsequently slash them ignited a rally in EM assets, with Latin American bonds seeing its strongest performance in over a decade.
“Central banks in many developing economies have sped ahead in the fight against inflation, hiking — and then cutting — interest rates far faster than their policymaking peers in the US and Europe,” Bloomberg reported. “That’s helped fuel what’s set to be the best annual rally in Latin American domestic bonds since 2009.”
Given this recent rally, asset management firms are positioning themselves for further strength in the EM bond market, including PIMCO. The prevailing sentiment for most of the capital markets is that rate cuts will happen in 2024, with some speculating as early as the first quarter. In effect, this should push the dollar down and EM local currencies higher.
“The closer we get to the Fed rate cut, the more investors will tilt toward local currencies,” said Ricardo Navarro, head of Latin American fixed income at Itau Unibanco Holding SA. “Investors want yield pick-up, and the thesis there is that without the Fed hiking further, you might as well get the bigger yield in EM currencies.”
Active Exposure in the Emerging Markets Bond Market
Fixed income investors looking to obtain exposure to the EM bond market are provided with an array of options. Because EM bonds carry their own risk profiles, each can present different challenges when deciding to invest in a certain debt holding or not. As such, there’s an easier way via the American Century Emerging Markets Bond ETF (AEMB).
Per its baseline fund description, AEMB uses active management to deliver high levels of income and attractive risk-adjusted returns over a full market cycle with a low 0.39% expense ratio.
Regarding holdings (over 150 of them), investors will see a mix of debt in corporate, sovereign, and quasi-sovereign. This gives AEMB a dose of diversification while maximizing yield at the same time. As of November 30, the ETF features a 30-day unsubsidized yield of about 7.65% and a 12-month distribution rate of 5.93%.
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