Emerging Markets Debt an Alternative Solution as Rate Cuts Loom

The capital markets will be waiting for the interest rate cut that equities want to hear, but what about fixed income? It’s made the bond market a more challenging environment, but emerging markets offer fixed income investors an alternative solution.

“With rates across the developed world depressed, income generation has once again become very challenging,” wrote Tim Urbanowicz, Invesco Senior Fixed Income ETF Strategist. “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.”

Federal Chair Jerome Powell gave the capital markets what they wanted to hear, which was leaving the door wide open for the possibility of interest rate cuts. For fixed income investors, a low-interest rate environment doesn’t bode well for high yield options, but one place they could look for is emerging markets debt.

“Fueling this opportunity further is the dovish US Federal Reserve (Fed),” Urbanowicz noted. “Probability of easing in 2019 has risen with 8 out of 17 Fed participants now seeing a cut this year.  The market also seems confident, as multiple cuts are now priced in before year end.”

While 2019 has thus far seen the reemergence of emerging markets after a rough 2018, are sifting through the plethora of opportunities the EM space has to offer. It’s wise to not overlook the high yield corner of the bond markets. With fears of a global economic slowdown putting the clamps on higher rates, emerging markets debt could be the miracle elixir for high-yielding asset allocation.

Of course, there’s the U.S.-China trade impasse that could also be a major factor with respect to the performance of emerging markets. For fixed income investors looking for opportunities within the EM space, a resolution between the two largest economies on trade would be a welcome option.

A Smart Beta Fixed Income Option

An option to consider in the EM bond market is the Invesco Emerging Markets Sovereign Debt ETF (NYSEArca: PCY). PCY seeks to track the investment results of the DBIQ Emerging Market USD Liquid Balanced Index .

PCY generally will invest at least 80 percent of its total assets in U.S. dollar-denominated government bonds from emerging market countries that comprise the underlying index. The underlying index PCY tracks measures potential returns of a theoretical portfolio of liquid emerging market U.S. dollar-denominated government bonds.

According to Yahoo! Finance performance numbers, PCY has yielded a 14.20 percent return thus far in 2019. The fund gives investors the necessary diversification versus relegating a portfolio’s fixed income allocation to domestic investment-grade debt.

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