(Sept 7): As government bonds from major economies buckle, funds including those run by JPMorgan Asset Management and BlackRock Inc have found an unlikely edge in emerging markets.

Government debt from the US to Japan has tumbled as energy-driven inflation and fiscal concerns revive the prospect of higher interest rates. Yet much of the developing world has escaped the worst of the selloff, helped by inflation that remains relatively contained, already-restrictive monetary policy and stronger fiscal positions in some countries.

High real interest rates and stronger fiscal positions in parts of the developing world are offering investors both income and a place to ride out volatility shaking the biggest bond markets.

The recent global bond selloff “makes EMs more attractive as they act as an income diversifier”, said Pierre-Yves Bareau, chief investment officer for emerging-market debt at JPMorgan Asset Management.

Local-currency emerging-market bonds have returned 3.6% this year even as US Treasuries and European peers have lost 0.6%, according to data compiled by Bloomberg. The MSCI EM currency index has advanced for 11 straight weeks, its longest stretch of gains since 2007, and hit another record high on Monday.

“It speaks to the asset class’s resilience,” said Elina Theodorakopoulou, a portfolio manager for emerging-market debt at Manulife Investment Management, who sees the recent selloff as “a relative opportunity for global emerging market debt”.

In contrast with developed market peers, emerging-market central banks have more room to chart their own course. Inflation across developing economies is running at an average 3.8%, according to JPMorgan, roughly a third of the level during the 2022 shock. The bank estimates policymakers have about one percentage point more cushion to absorb price pressures than they did four years ago. 

That flexibility is already on display. Brazil, Turkey and Hungary cut borrowing costs in August while South Korea and the Philippines tightened. The Czech central bank held rates after raising them in June.

“With inflation still contained and growth close to or slightly below potential in a number of EM economies, local rates should also be relatively well anchored in the face of the developed-market bond selloff,” said Chris Kushlis, chief emerging markets macro strategist at T Rowe Price. His team favours local-currency bonds in Brazil, Hungary, Mexico and South Africa.

Similarly, Michel Aubenas, BlackRock’s chief of emerging markets debt, is targeting bonds where he expects central banks to surprise investors by leaving rates unchanged.

BlackRock, like Societe Generale, favours Czech markets on the assumption that policymakers will not be pressed into raising rates. Market pricing indicates one 25 basis-point hike by the end of this year for a total of 100 basis points by mid-2027 but SocGen expects the Czech central bank to hold rates at 3.75% for the foreseeable future.

SocGen strategist Juan Orts also contends that market bets for the National Bank of Poland to unleash three quarter-point hikes are overblown.

“The market is always too aggressive,” said Bareau at JPMorgan, whose funds favour local-currency bonds and speculative-grade sovereign debt. “Even if some central banks will hike in front of inflation, they won’t deliver all the premium that the market is pricing.”

History also offers some encouragement. Emerging-market debt has typically performed well during Federal Reserve tightening cycles when higher rates are driven by stronger growth rather than inflation and fiscal stress.

Growth in emerging-market economies is expected to remain steady near 3.7% this year, a rate that’s helping shore up public finances and driving a favourable ratings trend in countries like Argentina, Ghana and Nigeria. By contrast, fiscal pressures are rising in big-spending governments in the developed world and driving up yields.

“The fiscal profligacy of developed markets in general makes EM more interesting,” said Thomas Christiansen, chief investment officer and head of EM debt at Union Bancaire Privee. “And to some extent, I believe that DM bond market moves over the past few weeks is a reflection of this.”

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