Outlook for Government Bonds In Emerging Markets

Outlook for Government Bonds In Emerging Markets
From Ihab Salib, Head of International Fixed Income, Federated Hermes Limited

Emerging Markets government bonds performed very well year to date and the outlook for the next few months is a continuation of the current trend.  Broadly speaking many EM sovereigns are moving in the right direction as it relates to fiscal and monetary policy.  Having experienced persistent high inflation in past cycles, many countries now have a greater appreciation for more prudent economic policies.  In this cycle, many EM countries raised rates much earlier and higher than their counterparts in the developed world to fight inflation. In addition, they adopted more conservative fiscal policies (less spending).  Also, many governments are more open to taking the necessary steps in order to earn IMF support and guidance.    

The market has rewarded the prudency with good performance. For example, the JP Morgan global diversified emerging market index returned 1.23% YTD as of May 29th.  The equivalent duration adjusted U.S. Treasury returns was -2.99% for the same period.   Clearly, emerging markets government bonds remained resilient to recent higher yields and interest rate volatility globally. 

We believe Emerging Market fixed income assets should be part of any fixed income portfolio. By investing in the asset class,  you are effectively diversifying your investment in 40+ countries with various political, fiscal, monetary policies, in different stages of their economic cycles.  The diversification benefits relative to other fixed income assets have been proven. The inclusion of EM fixed income improves risk adjusted returns.   

Also read: Peace Of Mind In A Shaky Market 

The opportunities in Emerging Markets often change quickly and require experienced active management.  For example, after disappointing performance due to various reasons for several years, Argentinian Government bonds may be an interesting investment opportunity.  The Government is being pragmatic and we’re finally beginning to see the legislation that is necessary for key reforms.  If enacted, these reforms would be a strong tailwind for bond performance.  Egypt is another example of a country we like.  Policy makers finally let the currency depreciate, which led to an IMF support package and a return of investors to the country. 

In terms of risk, we are more concerned from external shocks than risks coming from within emerging markets.  Equity market volatility, geopolitical risks, and US election risks can all induce a broad selloff in all risk markets which will likely effect EM assets as well.