Emerging markets have been battered by the COVID-19 pandemic, and more potential headwinds are ahead with rising inflation. Nonetheless, bargain hunters might see opportunities available, especially with EM bonds.
EM can be sensitive to global pressures, and with rising inflation, it’s no different. Rising interest rates are causing the U.S. dollar to rise, which typically spells doom for EM currencies.
“The IMF issued an ominous warning last week over rapidly-slowing global growth and the rising threat of an emerging-markets debt crisis,” MoneyWeek reports. “The fear is that the global slowdown, combined with surging inflation and rising interest rates, is likely to hit poorer and highly indebted countries especially hard by causing a slump in inward investment and driving down their currencies.”
Things have gotten more contentious when factoring in the Russia-Ukraine conflict. Investors who can stomach the pain in the short term, however, could be rewarded in the long term.
“The first blow is the potential for a short-term drying up of liquidity – and a broader ‘flight to safety’ that raises the cost of borrowing across emerging markets and increases the burden of debt,” MoneyWeek says. “The second is the broader macroeconomic picture of lower growth, and food and energy price shocks. The third is the likelihood of a long-term change in willingness to lend to high-risk sovereigns.”
Opportunities in EM Bonds
With greater risk also comes a greater potential reward. While the credit risk can be higher with EM bonds, a higher yield could be achieved with exchange traded funds (ETFs) such as the Vanguard Emerging Markets Government Bond Index Fund ETF Shares (VWOB).
VWOB in particular boasts a 5.64% 30-day SEC yield as of April 29. It can be an ideal solution for fixed income investors who want to diversify their portfolios and add an element of growth should the EM landscape improve.
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 USD Emerging Markets Government RIC Capped Index.
For more news, information, and strategy, visit the Fixed Income Channel.