The Federal Reserve probably won’t lower interest rates again anytime soon, but the yields on 10-year Treasuries and the S&P 500 remain paltry and it’s possible that the Fed will reduce borrowing costs again at some point in 2020.

Emerging markets debt instruments, including the VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC), can help investors generate more income via bonds.

EMLC seeks to replicate the price and yield performance of the J.P. Morgan GBI-EM Global Core Index. The index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer. While the asset class is currently struggling, there’s still a case for emerging markets debt denominated in local currencies.

“In our view, there is no reason for investors to avoid either high yield or more aggressive fixed income like emerging markets bonds,” said VanEck in a recent note. “Emerging markets debt is another area of opportunity, in our view. Lower interest rates in developed markets, we believe, may create room for emerging markets currencies to possibly fare better versus the U.S. dollar, and for emerging markets central banks to take a more dovish stance with their own interest rate policies to support growth.”

The Right Stuff

EMLC holds nearly 300 bonds and has a 30-day SEC yield of nearly 5.20%, which is well above what investors find on essentially domestic, investment-grade bond instruments.

The fund’s effective duration is 5.24 years, which doesn’t qualify as long-dated, but it’s high enough to provide adequate benefits from more relaxed monetary both in the U.S. and within the markets represent on EMLC’s roster.

“Along with attractive yields and valuations, we are also seeing positive economic reforms that have the potential to fuel this asset class—such as pro-growth reforms in Brazil and corporate tax cuts in India. From a portfolio construction perspective, we believe the diversification potential of emerging markets bonds—particularly local currency bonds—is among their most attractive features,” according to VanEck.

Declining interest rates in the U.S. and expectations that the Federal Reserve will continue lowering rates to prop up the economy could be a catalyst for EMLC. Emerging markets bonds, particularly those denominated in local currencies, are often levered to Fed action because lower U.S. rates can depress the dollar, thereby bolstering emerging markets currencies and assets denominated in those currencies.

For more trends, visit the Tactical Allocation Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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