Retreating Dollar Could Spur Interest in EM Bonds Again

The U.S. Dollar Index is down just under 5% within the past year, which should clear the path for interest in emerging markets (EM) assets like bonds again.

Typically, strength in EM is tied to the performance of the currency of that particular country versus the dollar. With rate hikes the past few years, a strengthening dollar has been pushing these currencies lower, souring investor taste for EM assets.

The recent rate pause by the Federal Reserve could indicate the central bank is near the end of tightening monetary policy and that inflation is cooling. A retreating greenback, in effect, should bode well for EM currencies heading into 2024.

“Emerging market currencies will take well into next year to start making noticeable gains against a retreating U.S. dollar, despite a growing view the interest rate cycle has peaked, a Reuters poll of FX strategists showed,” Reuters reported.

As previously mentioned, the recent rate pause could be the sign that bullish EM investors need. A flight from safe haven assets into riskier assets could push emerging market assets higher as investor sentiment tilts toward risk-on.

“After getting battered for most of 2023, emerging market (EM) currencies have made modest gains against the dollar after the Federal Reserve held interest rates steady last week and data suggested the U.S. economy might finally be slowing,” Reuters added.

Still an EM Contrarian Play

Despite the rate pause, there’s still no telling what the central bank will do. A rapid pivot back to rate hikes could once again push EM assets down. In essence, investing capital to emerging markets is still a contrarian play.

Still, there’s no denying the yield benefits that EM assets like bonds can offer. That said, for investors who are willing to accept the risk, consider the Vanguard Emerging Markets Government Bond Index Fund ETF Shares (VWOB).

Rising bond yields in the current bond market have made them an attractive fixed income option across the board. VWOB is no exception, with its 30-day SEC yield of 7.67% as of November 6.

VWOB seeks to track the performance of a benchmark index (the Bloomberg USD Emerging Markets Government RIC Capped Index), which measures the investment return of U.S.-dollar-denominated bonds issued by governments and government-related issuers in emerging market countries. The ETF offers an ideal solution for fixed income investors who want to diversify their bond portfolio with EM bonds

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