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 1.87% on Jan 18, 2022. As a result, investors have every reason to turn to emerging market (EM) bond ETFs for higher yields.
Moreover, rising inflation in the developed economies like the United States will likely divert investors to the emerging markets’ bonds. Inflation results in rising rates. And rising rates cast a spell of misfortune on bond ETFs investing.
The dual favors have probably kept several EM bond ETFs steady lately, with
First Trust Emerging Markets Local Currency Bond ETF ( FEMB Quick Quote FEMB - Free Report) gaining 1.13% past week against a 0.1% gain in PIMCO 25+ Year Zero Coupon US Treasury Index ETF ( ZROZ Quick Quote ZROZ - Free Report) . ZROZ is now yielding about 1.61%, while FEMB yields 6.04% annually.
Per an etf.com article, “emerging markets are not as popular when it comes to fixed income. In fact, of the $7.1 trillion in ETF assets, just under $34 billion is held in emerging market debt ETFs. As a share of fixed income assets, which stands at around $1.27 trillion, this represents about 2.6%.”
However, this does not mean you should ignore the space fully. We’ll tell you why.
A Spike in Inflation in Developed Economies
The rise in the inflation rate has been much sharper in emerging economies than in developed economies. Per a report by Reuters published in September, inflation has probably risen to 2.4% in 2021 from 0.7% in 2020 in developed countries and to 5.4% from 5.1% in developing economies. This shows that the rate of increase in inflation in developed economies is much higher than that in emerging economies. Since inflation is detrimental to bond investing, EM bonds offer a better scope right now.
A Bloomberg article pointed out last year 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 (read:
Disinflation in Emerging Markets? Buy EM Bond ETFs). Yields Are U.S. Treasury-Beating
The Fed is on a policy-tightening mode. The bank has paced up QE tapering and chances are high there will be more than one rate hike in 2022 with the first one hitting the market as soon as in March. As a result, U.S. Treasury bond yield is rising. Even then, yields are way below the EM ETFs. Plus, fixed-income securities are always less risky than equities. Even if EM bond ETFs end up with capital losses, the regular stream of current income will guard investors’ portfolio.
Steady Commodity Market
Commodity prices remained steady on a favorable demand-supply scenario and a decent greenback. Since several emerging markets are commodity-rich, rising commodity prices must have showered gains on the bourses of these countries. Oil prices are likely to pick up this year on a better demand outlook.
Invesco DB Commodity Index Tracking Fund ( DBC Quick Quote DBC - Free Report) has gained 6% in the past month. ETFs in Focus
Against this backdrop, below we highlight a few EM bond ETFs that are on high momentum currently.
First Trust Emerging Markets Local Currency Bond ETF ( FEMB Quick Quote FEMB - Free Report) – Up 1.30% Past Week; 6.04% Yield VanEck J. P. Morgan EM Local Currency Bond ETF (EMLC – Up 0.63% Past Week; Yield 5.54% SPDR Bloomberg Emerging Markets Local Bond ETF ( EBND Quick Quote EBND - Free Report) – Up 0.49% Past Week; Yield 4.12%