Bonds: Dollar Helps Emerging Markets

A.When the Corona crisis began in the spring and the financial markets played it safe, emerging market bonds also felt the effects. The yield on the ten-year Brazilian government bond shot up from 6.5 to 9.6 percent, the Thai from 0.8 to 1.8 percent. Since then, bond prices have recovered, but yields of 7.5 and 1.3 percent are still above pre-crisis levels.

“The outflow of hard currencies is only slowly returning,” says David Furey, who is responsible for fixed income strategies in Europe, the Middle East and Africa at ETF provider State Street Global Advisors. Investors are still overweight in developed country bonds. But slowly they became friends with a return. The fact that the real returns in the emerging markets are positive and currently offer a cushion of around 3 percentage points to cushion the risks is a tempting argument.

“We’re seeing institutional investors who have previously invested in emerging market bonds are starting to increase their quotas,” says Furey. “They see an entry opportunity at the current level.” But investors who are new to this asset class also seriously considered venturing into it. “The first step is always difficult,” says Furey. “Especially in Europe and especially in Germany. While in Europe the proportion of emerging market bonds in portfolios is only 4 to 8 percent on average, it is still significantly lower in Germany. “

Long-term dollar appreciation before the end

This is understandable anyway. The asset class is just once volatile, even more so for investors from the euro area than from dollar countries. In addition, the earnings have been rather low recently due to the high volatility. Exchange rate fluctuations have increased enormously since 2015, says Zsolt Papp, senior investment specialist for emerging market bonds at JP Morgan AM. This is mainly due to the loose monetary policy of the central banks. The contribution of currencies to earnings is still positive, but no longer as in earlier times. In addition, there have been individual periods with heavy losses

An end to the loose monetary policy is currently not in sight, says Papp, but hopes that the now looser monetary policy of the American central bank and with it the lower interest rate differential will make currency speculation less interesting in the future. Even more closely linked growth on both sides of the Atlantic could help calm the important euro-dollar exchange rate.

The dollar is a big part of emerging market bonds, and this is exactly what gives Furey reason to be optimistic. “The dollar’s appreciation cycle has been going on for nine years. So he’s pretty advanced. Historically, it is about ten years. This means that emerging market currencies are undervalued against the dollar as the dollar is overvalued. Even if the dollar should still appreciate – there is not much left to do. “

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To the detailed view

That is also the big difference to the time of the financial crisis. At that time, emerging market currencies were overvalued and the fundamentals were less positive than they are now. The pandemic will not change that. The grave situation in India or Brazil is more the exception than the rule. In addition, although the pandemic is a burden on national budgets, it does not affect inflation or exchange rates. “And the Biden presidency is expected to bring higher government spending and a less troubled geopolitical environment, and that’s good for emerging market debt.”

Papp also sees a good environment. “The impending stimulus packages, low inflation and expansionary monetary policy, and the prospect of a vaccine – that’s all good for stocks. And because it’s good for stocks, it’s good for emerging market bonds too. Because there is a strong connection between the two. After all, both are growth investments. “

Raphael Marechal, senior portfolio manager for emerging markets at the Asian specialist Nikko, sees an increasing demand for high-quality emerging market bonds. The financial outlook remained fundamentally difficult, but has improved, also because many governments in Chile, Peru and the Philippines, for example, have acted more cautiously than expected. A future risk is possible social unrest in countries like Colombia, Brazil or Ecuador, where apparently too little has been done to combat the pandemic. He therefore urges caution in countries that are heavily touristy such as Thailand, Sri Lanka, the Dominican Republic or Dubai.

The market is also calling into question the low level of real interest rates in Turkey, where foreign exchange reserves are being used to support the currency and short-term external financing needs are growing. In contrast, raw material producers like South Africa and Chile offer good opportunities to bet on the impressive upswing in the Chinese economy.


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