Declining U.S. Rates Boost EM Debt's Yield Advantage

Summary

• Ten year Treasury yield levels, which dipped below 1.20% earlier this month, seem to be at odds with a general narrative of non-transitory inflation and accelerating economic growth.
• Many emerging markets' central banks are ahead of the Federal Reserve with rate hikes, and although rates have adjusted higher, there have not been any local taper tantrums as the market has taken these moves in stride.
• On the high yield corporate side of emerging markets debt, yield and spread pickup against U.S. high yield remains at elevated levels relative to historical averages.

pabradyphoto/iStock via Getty Images

Since the end of the first quarter this year, U.S. Treasury yields have been on the decline, and at an increased pace in July. Ten year Treasury yield levels, which dipped below 1.20% earlier this month, seem to be at odds with a general narrative of non-transitory inflation and accelerating economic growth. Although technical and renewed COVID variant fears may be contributing factors to this most recent move downwards, the result is an ever-increasing yield gap between U.S. and developed markets debt and emerging markets debt.

Steady or Increased Yield Pickup in EM

Source: ICE Data Indices, J.P. Morgan, and FactSet as of 7/20/2021. EM HY Corporates is represented by ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index; US HY Corporates is represented by ICE BofA US High Yield Index; EM Local Sovereigns is represented by J.P. Morgan GBI-EM Global Core Index; China Onshore Bonds is represented by ChinaBond China High Quality Bond Index; US 10-Year Treasury is represented by ICE BofA Current 10-Year US Treasury Index; US Broad Market is represented by ICE BofA US Broad Market Index; Global DM Broad Market is represented by ICE BofA Global Broad Market Index.

We wrote last month about rising yields in many emerging markets as inflation and growth heat up, which may also provide a tailwind to emerging markets local currencies that remain at historically undervalued levels. Many emerging markets' central banks are ahead of the Federal Reserve (FED) with rate hikes, and although rates have adjusted higher, there have not been any local taper tantrums as the market has taken these moves in stride.

In China, the story is somewhat different. In early July, the People’s Bank of China cut the reserve requirement ratio by 50 basis points, freeing up cash that banks must hold as reserves and introducing additional liquidity into the system. Despite the cut, China’s real rate is still among the highest in the world and the action represents a fairly modest adjustment following significant normalization over the past year¹. For bond investors, the cut provided a boost to returns in addition to the significant appreciation from the Chinese yuan renminbi over the past year².

On the high yield corporate side of emerging markets debt, yield and spread pickup against U.S. high yield remains at elevated levels relative to historical averages. The attractive fundamentals of the asset class and higher quality tilt make the comparison even more favorable. Further, with no overlap to U.S. high yield and a lower duration, emerging markets' high yield corporates may help to diversify and reduce U.S. interest rate exposure within a global high yield allocation.

Diversification is also a key reason to consider local currency bonds in the current environment. With U.S. yield back to very low levels, concerns about rising rates may come back to the forefront very quickly. Adding exposure to broad emerging markets local currency bonds or targeted exposure to China’s onshore market may help to diversify away from U.S. interest rates and monetary policy, based on low or negative return correlations historically. Though seemingly far off, the Fed has telegraphed that rate increases are on their radar with the prospect of tapering current bond purchases even sooner. Adding emerging markets debt exposure may result in both a higher yielding portfolio and one that may be more resilient to future U.S. interest rate increases.

DISCLOSURES

Sources

¹ VanEck & Bloomberg

² Bloomberg

Index descriptions:

ChinaBond China High Quality Bond Index is comprised of fixed-rate, Renminbi ("RMB")-denominated bonds issued in the People's Republic of China by Chinese credit, governmental and quasi-governmental (e.g., policy banks) issuers.

ICE BofA Current 10-Year US Treasury Index is a one-security index comprised of the most recently issued 10-year US Treasury note.

ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index tracks the performance of US dollar denominated below investment grade emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

ICE BofA Global Broad Market Index tracks the performance of investment grade debt publicly issued in the major domestic and eurobond markets, including sovereign, quasi-government, corporate, securitized and collateralized securities.

ICE BofA US Broad Market Index tracks the performance of US dollar denominated investment grade debt publicly issued in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.

ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.

J.P. Morgan GBI-EM Global Core Index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

Please note that VanEck may offer investments products that invest in the asset class(ES) discussed herein.

This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed in this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(S), but not necessarily those of VanEck.

All investing is subject to risk, including the possible loss of the money you invest. Bonds and bond funds will decrease in value as interest rates rise. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Comments

[Diego Montalbon, raconteur]

"On the high yield corporate side of emerging markets debt, yield and spread pickup against U.S. high yield remains at elevated levels relative to historical averages. The attractive fundamentals of the asset class and higher quality tilt make the comparison even more favorable. Further, with no overlap to U.S. high yield and a lower duration, emerging markets' high yield corporates may help to diversify and reduce U.S. interest rate exposure within a global high yield allocation."

Hey VanEck, how about putting down the pom-poms on your high fee - high risk fund cheer leading and address the risks associated with lower global Gdp growth suggested by low sovereign debt yields that you yourself cite in the title of this infomercial.