What a Fed Rate Cut Means for Emerging Market Debt | ETF Trends

With interest rates across the developed world depressed, income generation has once again become very challenging, says Tim Urbanowicz, Invesco Senior Fixed Income ETF Strategist, in a recent note.

However, Urbanowicz pointed to opportunities in equal weighted fixed income in emerging markets.

“Currently, it appears there are very few places to generate yield, with 10-year rates in the Eurozone at negative 0.30%, and Japan at negative 0.15% and the US 10-year hovering around 2%, as of July 22, 2019,” Urbanowicz said. “Enter emerging markets (EM): as of July 22, 2019, Invesco Emerging Markets Sovereign Debt ETF (PCY), has an SEC 30-day yield of 4.80%, an effective duration – or measure of a bond’s sensitivity to changes in interest rates –  of 9.32 years, and 45% of the portfolio rated investment grade.”

Fueling this opportunity further is the dovish US Federal Reserve.

Urbanowicz noted that the probability of easing in 2019 has risen with 8 out of 17 Fed participants now seeing a cut this year. He added the market also seems confident, as multiple cuts are now priced in before year end.

“If we look at the last four easing cycles, USD EM debt has rallied an average of 9.5% in the 6 months following the first Fed cut, which makes a strong case for PCY,” he wrote.

PCY, the first smart beta fixed income ETF launched in 2007, is based on the DBIQ Emerging Markets USD Liquid Balanced Index, which tracks the potential returns of US dollar-denominated government bonds issued by more than 20 emerging-market countries, weighted equally.

With an effective duration of 9.32 years, PCY holds longer duration bonds (up to 30 years) that should react more sharply to a rate cut than the shorter end of the interest rate spectrum, as of July 22, 2019. This approach offers diversified exposure across emerging markets and can result in excess returns over the market value weighted counterparts.

For more news and strategies in fixed income, visit our Fixed Income Channel.