Last year, the strong dollar plagued a variety of asset classes, including emerging markets bonds and the related exchange traded funds. The strong greenback weighed on dollar-denominated emerging markets bonds, but was particularly punitive for local currency emerging markets bonds.
A stronger dollar usually means other currencies are weakening. In emerging markets, that scenario can lead to higher external financing pressures. The VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC), which holds bonds denominated in local currencies, suffered through the strong dollar scenario last year, but could be poised to rebound in 2019 if the dollar weakens.
“In an environment with less external pressure, we believe many emerging markets currencies could rally,” said VanEck in a recent note. “First, a slowdown and perhaps end of the Federal Reserve’s (Fed’s) rate hiking cycle seems likely in the coming year. With changing expectations, U.S. market interest rates have gone lower, providing downside pressure on the U.S. dollar and upside pressure on emerging markets currencies (EMFX).”
Inside ‘EMLC’ ETF
EMLC, one of the largest emerging markets bond ETFs featuring local currency debt, is up almost 2.60% to start 2019. The fund is being helped by its exposure to Latin America and Indonesia. Indonesia’s rupiah is one of the best-performing emerging markets currencies to start the new year. Brazil, Mexico and Indonesia combine for about 29% of EMLC’s geographic exposure.
“Other factors to consider include the possibility of stronger growth outside of the U.S. China’s stimulus measures in 2018 may kick in this year and provide a broader boost to the global economy, with emerging markets as a primary beneficiary,” according to VanEck. “Further, a widening U.S. current account deficit and decreased demand by foreign investors for U.S. bonds due to higher currency hedging costs may reduce dollar demand. Finally, in our view the dollar’s net speculative positioning looks elevated, creating ample room for the move down if the aforementioned factors materialize.”
EMLC has a 30-day SEC yield of 6.80% and an effective duration of 5.05 years, according to issuer data. Nearly 52.60% of the emerging markets bonds found in EMLC carry investment-grade ratings.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.