Following the strong first half for emerging market local currency debt, the question for investors is now whether the second half of the year will prove as fruitful. We certainly expect that some of the key themes prevalent in H1 could continue running. There are three important areas for investors to consider as we move through the year:
So these three potential drivers of returns look likely to be supportive in the coming quarters. The divergence in performance from Treasuries may add another reason to include emerging market exposure in fixed income portfolios. Figure 1 shows the rolling 12-week correlation in the changes in the returns from the Bloomberg Emerging Markets Local Currency Liquid Government Bond Index with the Bloomberg US Treasury Index. While correlations were high in the closing stages of 2022 (almost all bond markets sold off in 2022, with the inflection point in October, following which there was a widespread bounce), they have fallen quite sharply during 2023. This fall hints that the diversification benefits of emerging market bonds are returning.
Figure 1: Correlation of Changes to Returns of Emerging Market Local Currency Liquid Government Bonds with US Treasuries
There undoubtedly remain some challenges within the emerging market environment. Indeed, 5 of the 18 countries included in the Bloomberg Emerging Markets Local Currency Liquid Government Bond Index have posted negative returns year to date, largely due to currency depreciation against the USD. However, aside from South Africa and of course Turkey, the negative returns have been relatively small. Moreover, Turkey, a key drag on performance this year, appears to at least be stable. With a new team now in charge of managing the economy, bonds have rallied, although the lira remains weak.
Questions around global growth are also likely to persist but, having got on the front foot in the fight against inflation by hiking early, emerging market central banks are better able to respond to weaker growth by lowering rates. If we do see the long-awaited peak in US rates, this is only likely to give emerging market central banks more confidence that any easing will not trigger sharp declines in their currencies.
1 Source: Bloomberg Finance L.P. The Bloomberg Global Aggregate Total Return Index has returned exactly 2% year to date and the Bloomberg US Treasury Index has returned 2.11% against 6.7% for the Bloomberg Emerging Markets Local Currency Liquid Government Bond Index, as of 21 June 2023. Returns are in USD terms.
2 See Emerging Markets and How to Play Them, 30 May 2023.
3 Source: State Street Global Advisors, as at 31 May 2023.
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