11 February 2022
VanEck Blogs | Emerging Market Bonds
Meeting Demand for Income in a Year of Rising Rates

The market expects at least four rate hikes beginning in March setting the stage for a tough year for fixed income. Could emerging market bonds be a solution to meeting demand for income?

Federal Reserve Chairman Powell made clear after the recent FOMC meeting that the central bank was ready to raise rates and begin reducing its balance sheet to fight the highest inflation in a generation. The market is now expecting at least four rate hikes beginning in March, and this hawkish tone sets the stage for a tough year for most fixed income asset classes. A popular position right now for asset allocators is to seek the most attractive tradeoff for yield versus duration1, regardless of liquidity. Leveraged loans, private credit and vehicles categorized as “alternative finance” are meeting demand for income that involves low correlation with rates. Most of these alternatives, however, involve either a quality or liquidity give up, or both, that could compound downside during a negative turn in the credit cycle. We believe emerging market bonds remain part of the solution set, with attractive yield versus duration tradeoffs in some EM asset classes, and without as significant a quality or liquidity tradeoff as other high yielding options represent. EM debt may provide a relatively insulated pocket of opportunity to help build more resilient bond income portfolios in this environment.

All else equal, higher yielding asset classes may hold up better as rates rise because a higher level of income earned will help to offset price losses as rates rise. That is why some investors prefer asset classes like high yield corporate bonds over investment grade corporate bonds right now. Emerging markets high yield corporate bonds, as represented by the ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index, presently offer a significant pick up in yield versus U.S. high yield, as represented by the ICE BofA US High Yield Index, despite having a higher overall average credit quality. Within sovereign bonds, both U.S. dollar and local currency denominated bonds (as represented by the J.P. Morgan EMBI Global Diversified Index and JP. Morgan GBI-EM Global Core Index, respectively) provide relatively attractive yields, but U.S. dollar sovereign bonds are directly tied to U.S. rates and historically carry a high duration, currently at 7.7 as of 1/25/2022. Onshore China, as represented by ChinaBond China High Quality Bond Index, bonds provide lower yields than they did a year ago, but still offer a significant pickup versus U.S. treasuries and the broad U.S. investment grade market, as represented by the ICE BofA US Broad Market Index, without direct exposure to U.S. rates. In fact, China has been cutting rates recently, providing a tailwind to onshore bond returns.

Emerging Markets Yield and Duration Advantage

Emerging Markets Yield and Duration Advantage

Source: ICE Data Indices, J.P. Morgan and ChinaBond as of 1/25/2022. EM High Yield Corporate represented by ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index; LC EM Sovereigns represented by J.P. Morgan GBI-EM Global Core Index; USD EM Sovereigns represented by J.P. Morgan EMBI Global Diversified Index; US High Yield Corporates represented by ICE BofA US High Yield Index; China Onshore Bonds represented by ChinaBond China High Quality Bond Index; US IG Corporates represented by ICE BofA US Corporate Index; US Agg represented by ICE BofA US Broad Market Index.

Notwithstanding China’s more recent policy direction, emerging markets in general have moved much more quickly to increase interest rates compared to the U.S. and other developed market rates in order to stay ahead of inflation. The result has been not only higher nominal yields, but higher real yields. The benefits to EM local currency investors are a more substantial level of income that is not eroded by loss of purchasing power (through a potentially weaker currency) and the potential for rate cuts to stimulate growth, if needed. The supportive case for emerging market currencies begins with valuations, which have been deeply discounted relative to their history for several years. Further, with crude oil recently hitting its highest level since 2014, and many other commodities benefiting from growth and inflationary forces, many EM countries, particularly in Latin America, Africa and parts of Eastern Europe, stand to receive an extended economic boost. Net commodity exporters make up a much more significant portion of most EM local debt indexes than they do of EM equity indexes, which tend to be much more concentrated in the Asian export led economies.

For historical reference, below we show two extended rising rate, reflationary periods that have occurred since 2000. Local currency emerging market bonds performed well in both of these periods compared to rate sensitive U.S. investment grade aggregate bonds. Although EM local bonds underperformed U.S. high yield corporates slightly in the 2015-2019 period, the asset class is predominantly investment grade and therefore provided relatively safer exposure from a credit perspective. Emerging markets high yield corporates outperformed U.S. high yield corporates in this latter period (because index history does not exist prior to 12/31/2004, EM high yield is excluded from the 2004-2007 chart).

EM Debt vs US Fixed Income and Fed Funds 2004 – 2007

6/30/2004 - 6/30/2007

EM Debt and Fed Funds Target Rate

EM Debt vs US Fixed Income and Fed Funds 2015 – 2019

9/30/2015 - 6/30/2019

EM Debt and Fed Funds Target Rate 2015 - 2019

Source: J.P. Morgan, ICE Data Indices and Board of Governors of the Federal Reserve System as of 1/25/2022. EM HY Corp represented by ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index; LC EM Sovereigns represented by J.P. Morgan GBI-EM Global Core Index; US HY represented by ICE BofA US High Yield Index; US Agg represented by ICE BofA US Broad Market Index.

IMPORTANT DEFINITIONS & DISCLOSURES  

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This is not an offer to buy or sell, or a recommendation of any offer to buy or sell any of the securities mentioned herein. Fund holdings will vary. For a complete list of holdings in VanEck Mutual Funds and VanEck Vectors ETFs, please visit our website at www.vaneck.com.

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Information provided by third-party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this communication and are subject to change without notice. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from Van Eck Associates Corporation or its subsidiaries to participate in any transactions in any companies mentioned herein. This content is published in the United States. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed herein.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

Fran
Fran Rodilosso
Head of Fixed Income ETF Portfolio Management

Important Definitions & Disclosures

IMPORTANT DEFINITIONS & DISCLOSURES

This material may only be used outside of the United States.

This is not an offer to buy or sell, or a recommendation of any offer to buy or sell any of the securities mentioned herein. Fund holdings will vary. For a complete list of holdings in VanEck Mutual Funds and VanEck Vectors ETFs, please visit our website at www.vaneck.com.

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Information provided by third-party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this communication and are subject to change without notice. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from Van Eck Associates Corporation or its subsidiaries to participate in any transactions in any companies mentioned herein. This content is published in the United States. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed herein.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.