It's Early, But EM Bonds Are Rebounding

It's Early, But EM Bonds Are Rebounding

Amid the Federal Reserve's four interest rate hikes and the U.S. dollar ranking as one of 2018's best-performing major currencies, emerging markets bonds were among last year's most savagely repudiated asset classes.

Neither dollar-denominated emerging markets bonds nor the local currency equivalents were spared last year. A strong greenback pinches dollar-denominated debt issued by developing world governments by boosting external financing costs. When emerging markets currencies sag, as was the case last year, companies benefit if their revenue is earned in foreign currency, but there is no such respite for local currency debt.

Fast-forward to 2019 and the outlook appears to be more sanguine for emerging markets debt and the related exchange traded funds, including the JPMorgan USD Emerging Markets Sovereign Bond ETF ( JPMB ) . Yes, 2019 is still in its infancy, but a gain of 1.46 percent to start the year (as of January 10) for the JPMorgan USD Emerging Markets Sovereign Bond ETF ( JPMB ) is encouraging.

Of course, risks remain for emerging markets debt.

“The sector’s recent troubles highlight the inherent risks of investing in emerging markets government debt,” said Morningstar . “Some countries have a current account and / or budget deficit and are therefore more dependent on the export of goods.”

Rules Matter

The JPMorgan USD Emerging Markets Sovereign Bond ETF ( JPMB ) uses a rules-based methodology in an effort to minimize credit, liquidity and geographic risk. A rules-based weighting scheme is particularly useful on the geographic front because it can help limit investors' exposure to trouble spots, as Argentina and Turkey, among others, were last year.

Likewise, stringent screening factors, such as those employed by JPMB, can identify attractive opportunities with quality traits. Emerging Asian sovereign debt comes to mind.

“But other Asian nations still offer very high yields with low volatility – the Philippines, Indonesia and India in particular,” according to Asia Times . “Asian government bonds, as well as Asian credit, offer attractive yields and acceptably low volatility to dollar-based investors.”

JPMB's underlying index, the JPMorgan Emerging Markets Risk-Aware Bond Index, caps weights to countries that are large debt issuers by only including a specific portion of those countries' debt outstanding.

From a risk perspective, emerging markets debt looks attractive. Compensation for the risk that comes with U.S. high-yield corporate bonds started diminishing in earnest, so emerging markets debt is looking increasingly attractive for risk-tolerant fixed income investors. As of Nov. 30, 2018, the JPMorgan USD Emerging Markets Sovereign Bond ETF ( JPMB ) had a 30-day SEC yield of 6.25 percent, or 55 basis points above the comparable yield on the domestically-focused Bloomberg Barclays High Yield Very Liquid Index.

Related: Navigating Volatile Markets: Get Invested, Stay Invested

Rates, Rates And More Rates

While it is appearing increasingly likely that the Fed will slow its pace of rate hikes this year or not even raise rates at all, emerging markets central banks are getting hawkish. JPMorgan expects 19 of the 24 major developing economies it tracks to raise interest rates this year.

However, if the U.S. dollar declines, as many market observers are expecting, emerging markets central banks could be more deliberate with rate hike plans.

Bolstering the case for a fund such as the JPMorgan USD Emerging Markets Sovereign Bond ETF ( JPMB ) as 2019 unfolds is improving credit quality within the emerging markets investment-grade universe. In fact, the gap between emerging markets and U.S. investment-grade bonds has never been as narrow as it is today.