Investors remain relatively risk averse. That said, there is little evidence that recent market volatility has undermined confidence in emerging market (EM) debt, with the asset class seeing USD 72 billion of inflows during the first four months of the year.1 The high yield offered and relatively low correlation to Treasuries have underpinned the appeal of EM debt.2 The low correlation could become a more significant draw if the Fed decides to undertake further policy tightening and/or the debt ceiling becomes a bigger issue for US Treasuries.
Emerging market (EM) debt has been a theme in the Bond Compass for the past few quarters given historically high yields and the potential for USD declines to support performance. Returns year to date have been positive, with the Bloomberg EM Local Currency Liquid Government Index returning 5.8% to 9 May 2023. This return has been evenly split between currency returns (2.0%), bond price returns (2.0%) and coupons (1.7%).
As Figure 1 shows, most countries have seen positive returns with Brazil, Columbia, Czech Republic, Hungary, Indonesia, Mexico, Peru and Poland all returning in excess of 10% year to date. Three countries have weighed on performance: Israel, South Africa and Turkey, much of which has been the result of political issues. Turkey has a small weight in the index (1.5%) but the extremely negative returns, -21.5%, have resulted in around 40bp of drag.
Figure 1: Breakdown of YTD Returns for Bloomberg EM local Currency Liquid Government Index
The question on investors’ minds is whether this favourable backdrop for EM will persist. The first 4 months of the year have not been without their challenges. Rising US Treasury yields in February, in response to fears that the Fed would have to tighten more, also pushed EM yields higher. However, in contrast to the issues in March 2022, which saw investors desert EM debt, the problems in the US banking system saw EM local currency yields decline. This is significant, as the uncertainty generated by the nearing of the end of the Fed rate cycle and by US banking problems could easily have led investors to shy away from riskier assets.
Resilience in EM should have been helped by relatively high levels of conviction that returns from EM debt can remain strong in the coming months. Again, breaking down the stream of returns into the bond, forex and coupon components, all three have the potential to continue to deliver.
Please read our index overview to learn more about the differences across EM debt indices.
1 Source: Institute of International Finance, as of 30 April 2023.
2 Source: Bloomberg Finance L.P., as of 9 May 2023. The yield to worst on the Bloomberg EM Local Currency Liquid Government Index is 6.25% as at 9 May 2023. The correlation of the Bloomberg EM Local Currency Liquid Government Index to the Bloomberg US Treasury Index is 39.6% based on weekly data over the 2 years to 9 May 2023.
3 Source: Bloomberg Finance L.P., as of 28 April 2023. Coupon returns for the Bloomberg EM Local Currency Liquid Government Index were 1.62% over the first 4 moths of 2023.
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