As Rate Cut Expectations Increase, EM Currency Plays Are in Focus

A more dovish Fed could certainly help ease the strength of a U.S. dollar that flexed its muscle in 2018. As such, a rising U.S. dollar contributed to the weakness for emerging markets in 2018, but 2019 could see more retribution for the emerging markets (EM) space.

The Fed appeared to let off the rate-hiking accelerator pedal month by keeping rates steady thus far in 2019–a move that was widely anticipated by the capital markets–holding its policy rate in a range between 2.25% and 2.5%. Now, the expectation of a rate cut is portending to more weakness in the greenback.

The central bank has been trumpeting more dovish tones following the fourth and final rate hike for 2018 last December. To EM investors, that is music to their ears.

However, as the U.S. capital markets make their way out of the late cycle, it can be opportunities overseas that can be more attractive alternatives. Certain areas overseas may be earlier in their market cycles compared to the U.S. so issues like rate risk are not yet a concern.

“What we see now is that the dollar is probably topped out against a number of the emerging market currencies, ” said Mike Ryan, chief investment officer for the Americas at UBS Global Wealth Management.

“We do think there is a basket of emerging market currencies that look appealing as the Fed is poised now to begin cutting rates as opposed to raising rates,” he added.

An EM Local Currency Bond ETF to Consider

2019 thus far has been marked by strength in U.S. equities, which is translating to strength abroad as EMs are also gaining after a tumultuous 2018. While more investors are looking to add EM equities to their portfolios, they shouldn’t forget about EM bond exposure via exchange-traded funds (ETFs) like the VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC).

While the majority of investors might have been driven away by the red prices in emerging markets during much of 2018, investors are beginning to look at EM opportunities as substantial markdowns, especially if trade negotiations between the U.S. and China result into something materially positive as both sides struggle to break the current impasse.

Nonetheless, from a fundamental standpoint, EM assets are prime value plays as capital inflows continue.

EMLC seeks to replicate the price and yield performance of the J.P. Morgan GBI-EM Global Core Index. The index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

Additionally, EMLC may concentrate its investments in a particular industry or group of industries to the extent that the index also concentrates in a particular industry or group of industries. With investors confidence returning, so is a penchant for yield–something that can also be had via emerging market bonds via EMLC.

Bond markets overseas could provide more competitive yields when compares to those of the U.S. where credit risk in a late market cycle could pose a concern. On the topic of value, EMLC gives investors emerging markets debt exposure at a paltry 0.30% expense ratio.

As opposed to emerging markets equities that primarily concentrate on China, EMLC also gives investors exposure to other corners of the bond market for diversification. This can help ease any pain should a stronger dollar continue since EMLC’s holdings are less correlated to the greenback.

If investors can muster the strength to deal with any possible market oscillations, the returns could pay handsomely.

For more trends, visit the Tactical Allocation Channel.