EM HY Corporate Bonds Top List — Evening Brief – 05.14.24
Foreign fixed-income markets have largely proven unappealing to U.S. investors, with one notable exception: emerging-market corporate bonds. According to a group of ETFs, this segment of global fixed-income assets has been performing well this year.
Indeed, emerging-market corporate bonds have often held a unique allure for U.S. investors seeking higher yields and diversification beyond domestic markets. Despite the inherent risks associated with investing in them, such as currency fluctuations, political instability, and economic volatility, emerging market corporate bonds have been resilient.
This year, emerging market high-yield corporate bonds have performed particularly well. VanEck Emerging Markets High Yield Bond ETF (HYEM) is up 5.1% this year. WisdomTree Emerging Markets Corporate Bond Fund (EMCB), a (mainly) investment-grade holder of EM corporate bonds, is sharply lagging, up 2.2%.
Excluding corporate bonds, foreign bonds are down this year, with intermediate government bonds via developed countries ex-US down 5.2% (BWX). A US-dollar hedged global bonds ex-US benchmark (BNDX) is also down, mirroring the decline in U.S. government bonds.
“Emerging markets have done much better than anyone would have expected,” said David Hauner, head of global emerging markets fixed income strategy at Bank of America. “Clearly the credit component of EM sovereign bonds has held up well because the fundamentals have been improving.”
The surge in emerging market bond prices is even more astounding when you consider the headwind from the strong U.S. dollar. A U.S. dollar ETF proxy (UUP) is up 5.9% this year. All else being equal, a stronger dollar results in lower pricing for foreign assets when converted into dollars.
As a result, a strategy of hedging against U.S. dollar exposure has increased profits for EM high yield bonds. Additionally, the Federal Reserve’s delay in implementing possible interest rate cuts has contributed to the persistence of high interest rates in emerging countries, which has benefited foreign investors looking for yield.
Currency risk and increased volatility in emerging economies should weaken, if not erase, the premium in these nations’ fixed-income assets for U.S. investors, but for the time being, investors are ignoring that tail risk and firmly bidding up bond prices.