As Emerging Markets Volatility Dissipates, Reconsider Their Bonds

There’s still a lot of market uncertainty in the current environment as the Federal Reserve decides how to deal with inflation. In the meantime, confidence is coming back to emerging markets (EM), which could give their bonds a boost.

Rising interest rates have been pushing the dollar higher and applying pressure on emerging market currencies. EM assets are typically tied to the performance of the local currency against the dollar, so as the Fed continues to tighten monetary policy, this puts a stranglehold on what EM currencies can purchase in dollars.

The inflation narrative is turning into recession fears. As such, the Fed could become less hawkish on rate hiking and thus, an easing dollar can pave the way for EM strength and reduce volatility in EM assets.

“For the year-to-date period, we’ve seen EM volatility lower than [it is in] developed markets,” said Melissa Brown, managing director of applied research at Qontigo, noting that the volatility in EM is now 25% lower versus developed markets, according to Qontigo data.

The first half of 2022 was indeed a volatile one for the U.S. as major stock market indexes felt the selling pressure. Prospective investors in EM assets must still consider the risks, especially with ongoing market uncertainty and the potential of a global growth slowdown.

What [investors] should be concerned about is the risk-return tradeoff,” Brown added. “Maybe you need a higher return expectation in the U.S. relative to EM to justify taking on a higher volatility.”

An EM Bond ETF Opportunity

One EM asset to consider is bonds, and rather than opting for various holdings, there are exchange traded funds (ETFs) that can offer core exposure in one position. One worth considering is the Vanguard Emerging Markets Government Bond Index Fund ETF Shares (VWOB).

VWOB seeks to track the performance of a benchmark index that measures the investment return of U.S. dollar-denominated bonds issued by governments and government-related issuers in emerging market countries. The fund employs an indexing investment approach designed to track the performance of the Bloomberg Barclays USD Emerging Markets Government RIC Capped Index.

All of the fund’s investments will be selected through the sampling process, and under normal circumstances, at least 80% of the fund’s assets will be invested in bonds included in the index. The fund comes with a low 0.20% expense ratio.

For more news, information, and strategy, visit the Fixed Income Channel.