Investors Keep Betting on EM Bonds Despite Falling Spreads

One of the prime attractions of emerging markets (EM) bonds is the yields they offer. But with rates expected to ease, they also offer investors an opportunity for price appreciation. As such, investors are continuing to bet on rising EM bonds.

According to Investment News, the demand for EM bonds has been evident in the performance of a Bloomberg index of dollar-denominated debt for companies domiciled in EM countries. The index has been rallying since October of last year, hitting a level not seen since early 2022. That sent yields down by over 200 basis points, resulting in a closer spread with safer haven Treasuries.

This fall in yield, however, isn't pushing investors away from EM bonds. Instead, they're betting on further price gains that could accelerate once the Federal Reserve cuts interest rates.

"They say EM yields are high enough from a total-return perspective. And locking in income streams of close to 7% will look even more attractive whenever the Federal Reserve starts easing and global borrowing costs fall," the Investment News article said.

The narrowing yield spread should not only make EM sovereign debt attractive from a price appreciation standpoint, but also EM corporate bonds. In that instance, fixed investors could still attain attractive yields albeit more credit risk. However, they could still reap the rewards of price appreciation when rate cuts finally happen.

“Even with thin spreads, total valuations are comparatively attractive if investors are looking at a carry trade-strategy,” said Arnaud Boue, executive director and senior fixed income portfolio manager at Bank Julius Baer in Zurich. “We should see again a growing demand for EM corporate bonds when the Fed actually starts cutting rates as investors will seek higher-yielding papers.”