Emerging Market Bonds on the Rise
The Federal Reserve’s decision to restart the rate-cutting cycle is expected to further fuel the largest rally in emerging market bonds in recent years. According to information from Zhitong Finance, asset management managers and strategists are betting on this trend to continue. The benchmark index for dollar-denominated local government bonds of developing countries has delivered a 15% return to investors year-to-date, making it the best annual performance since 2017.
Causes of the Rally
The trigger for this rally was concerns over the U.S. economic outlook stemming from the Trump administration’s trade war and frequent policy shifts. This prompted investors to shift some of their capital into other markets. Now, after pausing interest rate hikes for nine months, the Federal Reserve has resumed cutting rates, further stimulating investors to seek higher-yielding assets.
Local Currency Bonds in Demand
Local currency bonds have become highly sought-after, with returns on bonds denominated in local currencies expected to be further amplified if the U.S. dollar continues to weaken. Fund managers at institutions such as Jeffrey Gundlach’s DoubleLine Capital and JPMorgan Asset Management are bullish on emerging market currencies and local bonds. Bank of America believes that emerging market carry trades will remain "irreplaceable" for the remainder of the year.
Analysts’ Views
"Investors’ willingness to allocate to non-U.S.-dollar assets is very clear," said Patrick Campbell, portfolio manager at Morgan Stanley Investment Management. "We are seeing a surge in interest in strategies that track benchmarks like emerging market local bonds—a level of enthusiasm we haven’t seen since 2012." Nathan Tufte, senior portfolio manager at Manulife Investment Management, noted that the Fed’s actions further support the view of "a weaker dollar and lower rates ahead," which is positive for emerging market equities and bonds.
Performance of Emerging Market Bonds
The broad-based rally in emerging markets is partly due to the erratic tariff policies of the Trump administration. Many emerging market central banks have adopted a cautious stance toward easing policies, making their asset yields more attractive. Emerging market government bonds have outperformed most global fixed-income assets, with a 15% gain that is more than double the return of US high-yield corporate bonds and far exceeds the 5.4% rise in the Bloomberg US Treasury Index. Countries such as Brazil, Mexico, Colombia, Hungary, and South Africa are leading the pack, with returns exceeding 23% year-to-date.
Risks and Future Prospects
While the current magnitude of the rally may limit future return potential, analysts and investors believe that the positive effects of the Fed’s previous monetary policy decisions will offset the risks. After announcing a 25-basis-point rate cut, the Federal Reserve also signaled that it would likely cut rates twice more before the end of the year. Emerging market central banks may follow suit with rate cuts, providing additional support to bonds. Inflation-adjusted yields in places like South Africa and Colombia may continue to attract carry trade inflows.
Conclusion
In conclusion, the Federal Reserve’s move to restart the rate-cutting cycle is expected to further fuel the rally in emerging market bonds. With local currency bonds becoming highly sought-after and returns on bonds denominated in local currencies expected to be further amplified, investors are bullish on emerging market currencies and local bonds. While risks persist, analysts and investors believe that the positive effects of the Fed’s previous monetary policy decisions will offset the risks, making emerging market bonds an attractive investment opportunity.
