My Thoughts on Emerging Markets Bonds

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Key Catalysts

  • US Dollar
    • US Interest Rates vs Foreign Interest Rates
    • US Growth vs Foreign Growth

My thoughts

The US dollar has been strong this year but it has begun heading down due to the slowing of the Fed's tightening cycle. The Fed is likely to slow its rate hike and eventually pause mid-next year. The reasons for this are

  • US consumer price inflation eased more than expected in November
  • Economic growth should slow as the rate hikes delivered this year by the U.S. finally begin to manifest their lagged effect on the economy
  • Cost-push inflation is likely to ease as supply chains are also finally normalizing as the world is getting back to normal following the pandemic, China reopening
  • Global economic recovery, economic recovery in China benefit a whole range of different economies, emerging markets included will help push the dollar down



The Case for Emerging Market Sovereign Credit

We have seen emerging market sovereign credit fall precipitously in 2022 due to
  • Rising U.S. real yields
  • Widening U.S. credit spreads
  • Stronger dollar
I expect these figures to reverse next year.

Hard currency vs. Local Currency
Sovereign bonds can either be denominated in local currency or hard currencies such as the U.S. dollar or Euro.
Local currency-denominated bonds are better if emerging markets tighten faster than the Fed. As the interests we receive would be worth more when EM currencies appreciate. However, there is the risk of continued Fed tightening which is bad for most fixed income but especially bad for EM local currency. Having said that, I am seeing more upside than downside as EM currencies have already slumped in 2022. We've also seen very little in the way of inflows into this part of the asset class over the past five years or so. 

Not all Emerging Markets are the same

  • debt levels are different across countries
  • some countries such as oil exporters benefit from high oil prices. 
  • some countries have more debt denominated in US dollars, now having to pay a very high cost due to stronger dollar
    • some have, in fact, already defaulted, but on the other hand, a lot are also being helped by the IMF.
    • If we look ahead to 2023, there are actually not that many debt maturities for the riskiest countries. 
That's why I have entered into positions in JPMB, JPMorgan USD Emerging Markets Sovereign Bond ETF, and LEMB, J.P. Morgan EM Local Currency Bond ETF.

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