Amid expectations that the Federal Reserve will reduce interest rates this year — perhaps multiple times, — there’s renewed interest in U.S. bonds, both corporate and Treasuries. However, fixed income investors shouldn’t take their eye of the international ball. That includes emerging markets debt and ETFs such as the Invesco Emerging Markets Sovereign Debt ETF (PCY).
Home to 98 bonds, the $1.48 billion PCY follows the DBIQ Emerging Market USD Liquid Balanced Index. The ETF is more than 16 years old, confirming it is battle-tested across a variety of market settings, including some that have been harsh to emerging markets bonds.
That’s in the past. Looking at the 2024 landscape for debt issued by developing economies, there’s budding enthusiasm for the asset class among professional asset allocators, and that could be a catalyst for PCY as this year moves along.
PCY Pertinent Bond Idea Today
There are catalysts for emerging markets bonds, perhaps even more so than what’s found with developed market equivalents, and that could bolster the case for PCY in 2024.
“There were significant outflows from EM assets as investor tolerance of risk withered and the US dollar strengthened amid growing concerns over the impact of higher inflation, rising interest rates, and a poor outlook on global growth,” noted BNP Paribas. “However, with confidence now growing that major central banks have succeeded in taming inflation without causing a hard recessionary landing, we expect flows to accelerate back into EM.”
Regarding emerging markets inflation, central banks in those economies were more proactive in raising rates to ward off rising costs than was the Federal Reserve. As such, some of those central banks already have lowered or will soon lower rates. That’s pertinent to investors considering PCY because the ETF has an effective duration of 10.05 years, indicating it could be responsive to monetary easing.
Should the Fed proceed with rate cuts, one of the results could be a weaker U.S. dollar, which is relevant regarding PCY because the fund holds dollar-denominated bonds. In fact, it was Fed tightening that led to a dearth in emerging markets bonds issuance — something that could work in PCY’s favor this year.
“On a technical basis, increased financing costs since the Fed began raising rates have reduced the supply of new bonds. This has resulted in bond issuers looking to alternative funding channels, especially in domestic markets. While we believe new bond issuance is likely to rise in 2024, we expect it to be moderate, meaning that a supply/demand imbalance is likely to persist into 2024, providing additional support to bond prices,” concluded BNP Paribas.
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