A higher-than-expected consumer price index (CPI) during the month of January may have pushed the dollar higher in the interim, but the overall trend portends declining strength once the U.S. Federal Reserve cuts interest rates. That should eventually pave the way for emerging markets (EM) bonds.
Local currencies in EM countries are susceptible to dollar strength and while the central bank has been keen on keeping rates steady, the expectation is that rate cuts will eventually happen. That said, investors may want to take advantage of EM assets now while they present themselves as value-oriented options, including bonds. That’s especially the case when it comes to history repeating itself with regard to declining dollar strength.
“More seasoned investors will observe that the dollar takes roughly decade-long swings: when it looks rich on most currency valuation metrics, as it currently does, its decline portends a boost to foreign stocks and bonds, especially those in emerging markets,” a Financial Times article confirmed.
So while that slow-cooking trend plays itself out, investors can soak up EM bonds at the current attractive valuations. Being that EM assets have been battered the last couple of years due to rate hikes, the upside may be too good to ignore thereby mitigating any risk involved.
“In other words, investors are now more highly compensated for the risks associated with emerging market currencies than they have been for more than a decade,” the Financial Times added. “Already many emerging market assets delivered strong returns in 2023 despite ongoing dollar strength. Any downward trend in the US currency could be a major spur for non-dollar assets.”
A Low-Cost, High-Yielding EM Bond Solution
With a low 20 basis points, one solution to get all-encompassing EM bond exposure is the Vanguard Emerging Markets Government Bond ETF (VWOB). The fund is deeply diversified, offering over 700 bond holdings with an average duration of just over seven years. As of February 13, the fund’s 30-day SEC yield is 6.84%, which should appeal to yield seekers.
Per its baseline fund description, VWOB seeks to track the performance of the Bloomberg USD Emerging Markets Government RIC Capped Index. The index specifically measures the investment return of U.S.-dollar-denominated bonds issued by governments and government-related issuers in EM countries.
Speaking once again to the fund’s deep diversification, VWOB invests in a broad spectrum of country-specific debt. This includes bonds from Saudi Arabia, Mexico, Turkey, Indonesia, and the United Arab Emirates, which round out the top five country allocations.
For more news, information, and strategy, visit the Fixed Income Channel.