Broadly speaking, exchange traded funds focusing on dollar-denominated and local currency emerging markets debt are performing admirably this year. With the Federal Reserve poised to soon lower rates, more of the same could be in store. It’s possible the VanEck J.P. Morgan EM Local Currency Bond ETF (EMLC) will be among the funds benefiting as monetary easing continues in developing economies and takes shape in the U.S. and other developed markets.
EMLC is reflecting that potential. That’s because the $2.78 billion ETF is higher by 5.2% over the three months ending Sept. 10. And that could serve as a springboard for more gains as the fourth quarter looms. EMLC offers some sources of allure. Those include a roster of bonds denominated in nearly 20 currencies – highlighting diversified currency risk – and a 30-day SEC yield of 6.14%.
Evaluating EMLC’s Favorable Traits
Quiet as it has been kept, EMLC outperformed the Bloomberg U.S. Aggregate Bond Index by 740 basis points over the past two years. A big reason for that sizable gap is because EM central banks, including those represented in the ETF, were faster to raise rates to ward off inflation. Thus, those central banks were able to lower rates before developed market counterparts could consider similar moves.
Now, all bond market eyes are on the Fed and the extent to which it will ease. There’s some conjecture about whether a 50 bp cut is in the offing this month. Consensus implies the U.S. central bank will have lowered rates by at least 150 basis points by Q2 2025. That could be to the benefit of emerging markets debt.
“Now what is important is how much and how fast that happens and why that is important is because market can digest so much,” noted Alaa Bushehri of BNP Paribas. “We are looking at a contained measure in terms of what the US Federal Reserve delivers and could be digestible by markets. What we are really looking out for are the extreme probabilities of, for example, no cut at all this year or much more than what market is expecting and can digest. That could contribute to volatility from here.”
Compelling Fundamental Case
The Fed could surprise with rate cuts that are more modest than expected. But there’s still a compelling fundamental case for EMLC because many developing countries have emphasized shoring up their fiscal positions in recent years.
“When looking at the different economies and the different fiscal balances, there has been a multi-year, multi-decade focus on improving those across the board and that has been reflected in [credit} spreads across the different jurisdictions,” added Bushehri. “When looking at those fundamentals and comparing them to peers in developed markets, we see that EM continues to provide a pick-up over DM peers when you’re looking at the same rating buckets. That continues to be the case and one we think investors should take advantage of.”
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