After recent lows, emerging market (EM) currencies appear to be on the rebound, helped by a weaker US dollar. An EM debt allocation may present investors with diversification and total return opportunities.
This article was written with contributions from Maciej Rabiniak. Maciej is a Research Analyst on the SPDR Americas Research Team.
As we closed the book on 2022, major stock indices finished the year down by double digits. China continued its gains, closing the week 1.3% higher. Gold rose by 0.7% as concerns mount over the continued slowing of the global economy. Treasury yields moved higher in December as the Federal Reserve pushed back on rate cuts in 2023.
Benjamin Netanyahu was sworn in as Israel’s Prime Minister for a record sixth time, leading a government seen as the most far-right since the country was established in 1948. In Brazil, Luiz Inácio Lula da Silva was sworn in as president. In his first address, he expressed optimism about plans to rebuild while pledging that members of outgoing Jair Bolsonaro’s administration will be held to account.
Starting on January 1, 2023, Croatia took two major steps to be more closely integrated with Europe. It joined the European Union's border-free Schengen zone, 27 European countries that do not require passports at their mutual borders, and it also adopted the euro as its currency.
The US labor market will be in the spotlight this week, as the latest change in US Nonfarm Payrolls and the unemployment rate are set to be released.
December CPI data for the eurozone will be released this week. It is largely expected to show slowing, though still elevated price growth.
Emerging market (EM) currencies have rebounded 9.5% since their October bottom, thanks to a weaker US dollar,1 as expectations of a slowdown in rate hikes and peak US rates are eroding the dollar’s yield advantage. Currency trends have historically played a significant part in explaining the risk and return of EM local debt,2 and a weakening dollar may provide tailwinds to this asset class which is currently yielding 6.38%, with a majority of issuers rated as investment grade.3 In addition, China has moved closer to reemerging from three years of government-imposed COVID isolation. This could potentially stimulate growth in emerging markets as well.
Given its yield and risk profile, an EM debt allocation may present investors with diversification and total return opportunities in today’s market. A weaker dollar could be a net positive for EM local debt; in months when EM currencies rallied, EM local debt’s return was positive 85% of the time with an average monthly gain of +2.29%, as shown in the chart below.4
EM Local Debt Rises as EM Local Currency Rises
To read more about the potential opportunity in EM local debt, and other areas that could be ripe for recovery in 2023, access our ETF Market Outlook: Find Opportunities in Discarded Markets.
1 Bloomberg Finance, L.P., as of December 30, 2022. EM currencies = J.P. Morgan GBI-EM Global Core Index. Performance period 10/24/2022 – 12/30/2022. Past performance is not a reliable indicator of future performance. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold.
2 Bloomberg Finance, L.P., as of December 30, 2022. EM Local Currency Government Diversified Index and the MSCI Emerging Market Currency Index based on monthly returns from 2008-2022. Past performance is not a reliable indicator of future performance. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.
3 ssga.com, as of December 30, 2022, based on index characteristics.
4 Bloomberg Finance, L.P., as of December 30, 2022. EM Local Currency Government Diversified Index and the MSCI Emerging Market Currency Index based on monthly returns from 2008-2022. Past performance is not a reliable indicator of future performance. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.
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Foreign (non-U.S.) Securities may be subject to greater political, economic, environmental, credit and information risks. Foreign securities may be subject to higher volatility than US securities, due to varying degrees of regulation and limited liquidity. These risks are magnified in emerging markets.
Bond funds contain interest rate risk (as interest rates rise bond prices usually fall); the risk of issuer default; issuer credit risk; liquidity risk; and inflation risk. There are additional risks for funds that invest in mortgage-backed and asset-backed securities including the risk of issuer default; credit risk and inflation risk.
Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole.