As government bonds in major economies suffer sharp declines, funds managed by institutions such as JPMorgan Asset Management and BlackRock have found an unlikely advantage in emerging markets.
Government bonds from the United States to Japan have tumbled as energy-driven inflation and fiscal concerns reignite the possibility of higher interest rates. However, much of the developing world has escaped the worst of the sell-off, helped by inflation that remains relatively controlled, already restrictive monetary policies and stronger fiscal positions in some countries.
High real interest rates and stronger fiscal positions in some parts of the developing world are offering investors both income and a place to ride out the volatility that has been roiling the biggest bond markets.
The recent wave of global bond sales "makes emerging markets more attractive as they act as an income diversifier," said Pierre-Yves Bareau, chief investment officer for emerging market debt at JPMorgan Asset Management.
Emerging market bonds in local currency have returned more than 3% this year, while US Treasuries and equivalent European bonds have lost 0.6%, according to data compiled by Bloomberg.
"This demonstrates the resilience of this asset class," said Elina Theodorakopoulou, emerging markets debt portfolio manager at Manulife Investment Management, who calls the recent sell-off a "relative opportunity for global emerging market debt."
Unlike their peers in developed markets, emerging market central banks have more room to follow their own path. Inflation in developing economies is averaging 3.8%, according to JPMorgan, roughly a third of the level recorded during the 2022 shock. The bank estimates that monetary policymakers have about 1 percentage point more leeway to absorb price pressures than they did four years ago.
This flexibility is already evident. Brazil, Türkiye and Hungary reduced borrowing costs in August, while South Korea and the Philippines tightened monetary policy. The Czech central bank maintained rates after raising them in June.
"With inflation still subdued and growth at or slightly below potential in several emerging economies, local rates should also remain relatively well-anchored in the face of a wave of developed market bond selling," said Chris Kushlis, chief emerging markets macro strategist at T. Rowe Price. His team prefers local currency bonds from Brazil, Hungary, Mexico and South Africa.
Similarly, Michel Aubenas, head of emerging market debt at BlackRock, is targeting bonds from countries where he expects central banks to surprise investors by keeping rates unchanged.
BlackRock, like Societe Generale, prefers Czech markets, assuming that monetary policymakers will not be pressured to raise rates. Market prices indicate a rise of 25 basis points by the end of this year, totaling 100 basis points by mid-2027, but SocGen expects the Czech central bank to keep rates at 3.75% for the foreseeable future.
SocGen strategist Juan Orts also argues that market bets that the National Bank of Poland will deliver three 25 basis point hikes are overblown.
"The market is always too aggressive," said JPMorgan's Bareau, whose funds favor local currency bonds and speculative-grade sovereign debt. "Even if some central banks raise rates to combat inflation, they will not deliver the full premium that the market is pricing in."
The story also offers some encouragement. Emerging market debt typically performs well during Federal Reserve monetary tightening cycles when higher rates are driven by stronger growth rather than inflation and fiscal stress.
Growth in emerging economies is expected to remain stable at close to 3.7% this year, a rate that is helping to strengthen public finances and driving a favorable trend in the credit ratings of countries such as Argentina, Ghana and Nigeria. In contrast, fiscal pressures are rising on governments in large developed economies, which have been spending heavily, and this is pushing up bond yields.
"The fiscal recklessness of developed markets generally makes emerging markets more interesting," said Thomas Christiansen, chief investment officer and head of emerging market debt at Union Bancaire Privee. "And to some extent I believe the movements in developed country bond markets in recent weeks are a reflection of that."
