Emerging markets have entered this year well on their way to recovering from the negative effects of a strong US dollar and outsized GDP growth in the US, asset management firm Schroders PLC said in a report yesterday.
The British company threw its weight behind emerging market bonds on the grounds that they might see price gains, as the US economy is expected to slow and the eurozone stalls.
“We find non-investment-grade dollar bonds in emerging markets attractive, as most stressed countries have gained large strides toward fundamental stability,” Shroders said.
Although growth would be slower this year, it is unlikely that macroeconomic imbalances would threaten a recovery in asset prices, it added.
Yields on emerging market bonds are approaching 7 percent, comparable to the levels during a sell-off from 2014 to 2016, when the US Federal Reserve ended quantitative easing and raised interest rates, it said.
However, investors might not feel comfortable until there is greater clarity about when the Fed would reverse its tightening monetary cycle, Shroders said.
The firm said it sees the prospects for US dollar debt in emerging markets as being favorable, with yields on non-investment-grade debt growing faster than those of investment grade.
Last year, Turkey and Argentina were the most severely stressed countries, but both seem to have stabilized their currencies and external deficits at levels that markets are now comfortable with, Shroders said.
In other less vulnerable countries such as Indonesia and Mexico, interest rates have risen, but not to levels that would cause significant slowdowns into this year, it said.
While returns were deeply negative, countries avoided spending foreign exchange reserves in a search for currency stability, Shorders said.
Looking forward, it would take an unambiguous turn in the US dollar to allow investors to benefit from sustained currency rallies across the asset class, the company said, adding that it might be an event beyond this year if the Fed remains on its current path of hiking interest rates.
Shroders said that growth in the asset class should recover slowly and major recessions in key countries are unlikely.
Until the US dollar signals a fall, local currency bonds as a whole would be challenged to deliver returns comparable to dollar bonds, it added.
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