Dollar Doubters Seed Historic Gains for Developing World Debt
The surge in demand for fixed-income assets in EM currencies is largely the flip side of sinking confidence in the US dollar, which has tumbled almost 11% this year. That's its worst performance since the 1970s, and the losses are across the board, with the greenback falling against 19 of the 23 most-traded emerging-market currencies, and by at least 10% against 10 of them.
The upshot is that an index of emerging-market local debt has returned more than 12% in the first half of the year, according to data compiled by Bloomberg, beating hard-currency bonds, which were up 5.4% in the same period. The first-half gains were the strongest since at least 2009.
'I don't think anyone had this much dollar weakness on their bingo card,' said Edwin Gutierrez, head of emerging-market sovereign debt at Aberdeen Group Plc. 'We thought local-currency debt would outperform hard-currency, but not by the magnitude that it ended up.'
The money is flowing in unprecedented amounts. EM-debt funds attracted more than $21 billion so far this year, Bank of America Corp. said on Wednesday, citing EPFR Global data. These funds drew inflows for each of the past 11 weeks and $3.1 billion in the week through July 2.
Boosting the case further is the prospect of interest-rate cuts in developing countries, according to Lewis Jones, a debt manager at William Blair Investment Management in New York.
'We expect more capacity from emerging central banks to cut rates, and also the trend of a weaker dollar versus the euro to continue,' he said. 'For European investors it could look more attractive looking forward.'
Latin American economies have handed investors some of their best returns, with Mexico's local bonds, known as Mbonos, generating a gain of 22%, while some of Brazil's government bonds have returned more than 29%. The Brazilian notes bounced following a sharp selloff late last year, while traders piled into bets that policymakers are done with their hiking cycle.
'We remain invested in Mexican bonos, the trade is not over for us,' said Adriana Cristea, senior investment manager at Pictet Asset Management, adding that the firm has positions in local bonds across emerging markets regions, from Latin America to EMEA and Asia.
Improving economic fundamentals in some emerging markets may also bring new issuers to the market. Ghana, Africa's top gold producer, is planning to resume domestic bond sales later in 2025 after short-term borrowing costs fell to the lowest in three years.
Easing tensions between Israel and Iran also boost the investment case for local debt from the developing world.
Despite the rally, Aberdeen's Gutierrez isn't yet looking to take profits on positions in EM local debt. He said his main overweights are Colombia, the Philippines and South Africa.
More broadly, investors favor Brazil, South Africa and Turkey, BofA's head of global emerging markets fixed-income strategy David Hauner wrote in a note on July 3 based on feedback from clients.
'It will be a multi-year process' of rethinking US exposure, said Brad Godfrey, co-head of emerging markets debt at Morgan Stanley Investment Management, who helps oversee $20.6 billion. 'It will be a relearning process for some people that hadn't been exposed to local in a while.'
--With assistance from Selcuk Gokoluk and Srinivasan Sivabalan.
More stories like this are available on bloomberg.com
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