Dollar-denominated emerging market bonds and related exchange traded funds are under increased pressure as the Federal Reserve hikes interest rates, trade tensions escalate and the U.S. dollar strengthens.
Year-to-date, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and Invesco Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), which both track USD-denominated emerging market debt, declined 6.5% and 8.2%, respectively. In comparison, the iShares 7-10 Year Treasury Bond ETF (NASDAQ: IEF) only weakened 2.0% so far this year.
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The average yield on USD-denominated emerging market bonds has increased to to 4.7% from 3.7% at the beginning of the year, reports Mike Bird for the Wall Street Journal. Bond prices and yields have an inverse relationship, so a rising yield corresponds with falling bond prices.
Given the sell-off in emerging assets this year, Asian developing countries, which are among the biggest issuers of dollar bonds, have seen yields push up to their highest level in almost five years.
According to the Bank for International Settlements, developing countries have issued $2 trillion in outstanding dollar-denominated bonds, tripling the amount issued in the past decade.
The sell-off in emerging market debt has been exacerbated by growing concerns over trade tensions between the U.S. and China.
Beyond the short-term volatility associated with the trade fears, many are wary of the diverging monetary policies between emerging central banks and the Federal Reserve, which is expected to hike interest rates two more times this year. While central banks in developing countries could also respond with their own rate hikes, the higher interest rates would stifle growth.
The International Monetary Fund calculates that due to U.S. rate hikes, bond sales this year and next year could reduce inflows into emerging markets by about $70 billion, compared to the $260 billion flowed into those economies since 2010 as a result of the Fed’s previous loosening policies.
Nevertheless, there are some that argue the recent selling may be overdone.
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“We don’t think this is an accurate pricing of emerging-market fundamentals,” Mark Baker, an investment manager at Aberdeen Standard Investments, told the WSJ. “It’s not like 2013 when big countries were running current-account deficits. There’s not much inflation about.”
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