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Emerging dollar bonds likely to rise along with Fed rate hike

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(Bloomberg) — Emerging-market dollar bonds are starting to look like a bargain.

The additional yield offered by sovereign debt of developing countries on US Treasuries has announced above 500 basis points, crossing a threshold that has only been exceeded twice in more than a decade. This is being done by Money managers, including FIM Partners and Vontobel Asset Management, to bet that spreads will fall rapidly, as they did after previous spikes.

As the Federal Reserve prepares to raise interest rates this week, investors are seeking assets that may outperform amid tighter monetary conditions and a stronger dollar. Emerging-market dollar-denominated bonds seem like the perfect fit and have a history of rallying during Fed rate hikes. Whether the worsening war in Ukraine — or the fallout from a Russian debt default that could occur on Wednesday — may derail this trade, fear of missing a market bottom is pushing investors to selectively buy the stock.

“Emerging market spreads have never ended a calendar year with a negative return by starting above 300 basis points,” said Francesc Balcells, chief investment officer for emerging market debt at FIM Partners in London. “There is a lot of negativity on debt right now.”

A JPMorgan Chase & Co. measure of the sovereign risk premium in emerging countries rose to 526 basis points on March 8, surpassing the 507 basis points reached after the Fed’s 2015 rate hike and the 468 basis points reached in 2011 following the downgrade of the US credit rating. On both occasions, bonds rallied, reducing the spread on developing debt to about 250 basis points. A surge during the March 2020 covid-related crash was also followed by a gain within weeks.

FIM Partners has started buying debt issued by countries in the Persian Gulf and Latin America, and is looking at hard-hit high-yield debt, such as Oman. The asset manager will also invest in new speculative-grade-rated debt offerings from Bahrain and Colombia, which “will come with large concessions” to its existing debt, Balcells said.

Adding to the bullish sentiment, history suggests that emerging market dollar debt tends to rally once the Fed’s hikes kick in, as it offers investors a way to own higher-yielding assets without the risk of the local currency.

“Emerging market hard currency gaps are likely to tighten once the Fed starts to hike rates, as it has in the past three rate hike cycles,” said Carlos de Sousa, money manager at Vontobel.

Selective Bets

But low prices alone are not enough to keep investors interested in emerging-market assets, especially as a raging war threatens to boost inflation and dent global growth. Goldman Sachs Group Inc. said it is premature to buy Asian credit now despite a downturn, given the potential for a wide range of outcomes from the Russian invasion of Ukraine.

Money managers returning to the asset class have become choosy, favoring longer-maturity bonds that are less sensitive to higher rates or the debt of countries benefiting from the commodity boom.

De Sousa de Vontobel prefers Ecuador because crude oil prices around US$110 a barrel reduce the nation’s need to tap foreign capital markets.

original note:

Too Cheap To Ignore, Emerging Dollar Bonds Will Fly With Fed (1)

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