EM bonds: Search for yield drives positive momentum

Alejandro Hardziej, Fixed Income analyst at Julius Baer, explains how further easing from core central banks intensifies the search for yield and should continue to support inflows into EM.

Emerging market (EM) bonds continue to enjoy a positive momentum, both in local and hard currency, supported by low interest rates in the developed world.

Over the past 12 weeks, more than $16bn have flown into emerging market dedicated funds, mostly into the hard-currency space, as illustrated in the chart below. We expect the recent easing by core central banks (Bank of England and Bank of Japan) to intensify the search for yield, reinforcing the momentum of emerging market assets.

However, we note that valuations are moving well ahead of fundamentals.

Since the beginning of the year, hard-currency corporate bonds have returned 9.7% on average, with spreads tightening by 68 basis points – as much as 175 and 376bps in the energy and metals and mining space, respectively.

In local currency, the performance has been even more impressive, with an average return of 15.2% year-to-date. While we are indeed seeing underlying fundamental improvements for most issuers, both at country and company levels, we believe they are being greatly outpaced by valuations.

Thus, emerging market bonds do not look cheap anymore and are becoming an increasingly crowded segment, which increases the possibility of temporary setbacks.

However, with absolute yield levels still looking reasonable and interest rates in the developed world unlikely to move higher anytime soon, the positive momentum should continue.

Source: Merrill Lynch, JP Morgan, Julius Baer

Source: Merrill Lynch, JP Morgan, Julius Baer



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