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EM Debt Outshines Dollar Bonds Amid Yield Surge
21 Sep
Summary
- Local emerging market debt is favored over dollar-denominated bonds.
- Attractive valuations and carry trades are key investor strategies.
- Local EM debt has outperformed dollar bonds by over 3% since June.
Emerging market investors are currently demonstrating a strong preference for local-currency sovereign debt, a shift away from dollar-denominated developing-nation bonds as Treasury yields have surged. This strategic pivot is underpinned by the appeal of attractive valuations and the potential to leverage carry trades, a practice involving borrowing in low-yield currencies to invest in higher-yield assets.
The preference for local EM debt is demonstrably evident in fund flows, investor positioning, and relative performance. A recent Bloomberg gauge indicates that domestic EM debt has outperformed an index of dollar-denominated bonds by over 3 percentage points since the end of June. This marks the most significant quarterly outperformance seen since 2022.
Further supporting this trend, a Bank of America survey revealed that 84% of global fixed-income fund managers were overweight local EM debt compared to hard currency bonds, a notable increase from 38% in August. Despite this strong momentum, the local EM debt trade may face future challenges. Potential further interest rate hikes by the Federal Reserve and a possible strengthening of the U.S. dollar could deter investors from emerging-market assets, including local-currency debt.
