EM Government Bonds Reap The Rewards Of Fiscal Responsibility

Over the last five years, EM local currency debt has outperformed G7 government debt despite COVID, unprecedented Fed tightening, a strong dollar rally, wars in Ukraine and Gaza, and a slowing China.

Even a cursory examination of emerging markets (EM) local currency sovereign debt performance over the past few years relative to developed markets (DM) counterparts reveals some interesting observations. This period has been characterized by extreme volatility across all fixed income asset classes, and EM debt investors were not insulated from this despite the high yields offered by the asset class. However, many investors may be surprised that EM local debt outperformed DM government bonds in this period – which includes the onset of COVID, unprecedented Fed tightening, a very strong dollar rally, the war in Ukraine, and a slowdown in Chinese economic growth.

EM vs DM Government Debt: 12/31/2018 – 1/31/2024

Hard currency EM debt has outperformed both DM government bonds and EM local currency bonds by a much greater degree over the past two decades, and we believe that the same outperformance drivers have now begun to benefit local currency debt – in particular, the absence of “fiscal dominance.” It is notable that EM local currency bonds outperformed DM government bonds in 2022, an extremely bad year for most fixed income asset classes, as well as 2023 when all bonds rallied, as discussed in Bull or Bear? Emerging Markets Bonds Outperform in Both. In other words, it was not simply the U.S. economic trajectory that has been driving returns. Superior fundamentals may explain this divergence in performance in both bull and bear markets.

Low debt and deficits have allowed emerging markets’ monetary authorities to conduct inflation-focused monetary policy, while high debt and deficits in developed markets have diluted central bank independence and their focus on inflation. Global bond markets are now beginning to recognize the risks embedded in DM government debt and reward the responsible fiscal and monetary policies that have been pursued by many emerging markets over the past several decades. We explore these dynamics and what is means for global bond investors going forward in Fiscal Dominance: The Clarifying Lens for EM (and DM) Bonds.

Investing in EM Bonds with VanEck

The VanEck Emerging Markets Bond Fund (EMBAX) is a high active share emerging market bond investment solution with the flexibility to invest across sovereigns, corporates, USD and local currency bonds. The fund is managed using a consistent approach across markets to find the best opportunities across the EM debt universe. The VanEck J.P. Morgan EM Local Currency Bond ETF (EMLC) provides access to bonds issued by emerging market governments and denominated in the local currency of the issuer, and may be attractive to investors seeking passive exposure to the broad EM local currency sovereign bond market.

Disclosures

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. 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 or its other employees.

Duration measures a bond’s sensitivity to interest rate changes that reflects the change in a bond’s price given a change in yield. This duration measure is appropriate for bonds with embedded options. Carry is the benefit or cost for owning an asset. Yield to worst is a measure of the lowest possible yield that can be received on a bond with an early retirement provision. Averages are market weighted. The yields presented do not represent the performance of the Fund. These statistics do not take into…