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Disinflation in Emerging Markets? Buy EM Bond ETFs

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The hunt for yields is common in a low-rate environment. This holds good for investors in the U.S. market where yield on the 10-year Treasury note was hovering around 1.15% as of Feb 4, 2021. As a result, investors turned to emerging market bond ETFs in search of higher yields.

Moreover, rising inflation in the developed economies like the United States, will also likely to divert investors to the emerging markets’ bonds. Per a Bloomberg article, inflation is a crucial part for bond returns. U.S. inflation-adjusted benchmark treasury yield was negative 1.02% on Feb 4, 2021.

Global treasuries in January fell as the Biden administration announced its plan to launch a $1.9-trillion stimulus package. iShares iBonds Dec 2025 Term Treasury ETF (IBTF - Free Report) has been the best performer in the past month with about 0.09% gains and 0.64% annual yield. Meanwhile, iShares Interest Rate Hedged Emerging Markets Bond ETF (EMBH - Free Report) is the best-performer in the EM segmentwith about 0.87% gains and 2.76% annual yield.

This, in turn, boosted the possibility for fund inflows into the regions that have more subdued price pressures, the Bloomberg article noted. "Local-currency emerging-market debt has dropped 0.4% in the past month, less than a third of the loss that its G-7 peers incurred", the Bloomberg article noted.

Disinflation in Emerging Markets?

The article also pointed out that the projected inflation for a cross-section of developing nations will average 4.74% from 2026 to 2031 versus an average of 5.25% over the past five years, according to the analysis. This is a disinflationary situation. Investors should note that disinflation is the fall in the rate of inflation.

“The disinflationary outlook offers a potential capital gain and a stable high income from emerging-market debt,” according to Akira Takei, a global fixed-income money manager in Tokyo at Asset Management One Co., which manages the equivalent of about $510 billion, as quoted on Bloomberg. Slower rollout of vaccines may also keep the EM inflation under check.

On the other hand, the United States has been witnessing a reflationary trade of late. The U.S. five-year forward five-year inflation swap, which measures expectations for future inflation, jumped to 2.45% this week from as low as 0.97% during the start of the coronavirus selloff in March, per the Bloomberg article.

Break-even inflation rates implied by U.S. bond prices touched 2.19% per annum on Feb 3 between now and 2031, marking the highest such forecast since August 2014. Notably, the annual inflation rate in the United States increased to 1.4% in December 2020, from 1.2% in November and slightly above the market forecasts of 1.3%.

The very situation explains why EM bonds are better bet than developed market bonds at the current level. However, dollar-denominated bonds appear to be better bets here as the greenback has been rising lately. Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) has been up 1.7% past month.

ETF Picks

Against this backdrop, below we highlight a few EM dollar denominated bond ETFs that could be good picks now.

Invesco Emerging Markets Sovereign Debt ETF (PCY - Free Report) – UP 0.68% Past Month; 4.46% Yield

Invesco BulletShares 2024 USD Emerging Markets Debt ETF (BSDE - Free Report) – Up 0.5% Past Month; 3.46% Yield

ProShares Short Term USD Emerging Markets Bond ETF (EMSH - Free Report) – Up 0.38% Past Month; 1.77% 30-Day SEC Yield

Invesco BulletShares 2023 USD Emerging Markets Debt ETF (BSCE - Free Report) – Up 0.21% Past Month; 3.73% Yield

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