Government bonds are selling off all over the world, at least all over the developed world. Emerging market bonds are a different story, particularly those issued in local currencies.
The iShares J.P. Morgan EM Local Currency Bond exchange-traded fund has gained more than 3% this year, and nearly 20% since the day U.S. President Donald Trump reassumed the Oval Office last January. That's probably not a coincidence.
Valuations could keep rising after long years of underperformance and underweighting. "EM local currency has been without flows since the Taper Tantrum of 2013," says Andrew Keirle, global portfolio manager for emerging market fixed income at T. Rowe Price. "It's been a discarded asset class until recently."
Taper Tantrum refers to a move by the U.S. Federal Reserve to pare back its purchases of U.S. sovereign bonds, or quantitative easing, which provoked a flood of capital into U.S. assets.
The most obvious driver for the current rally is a weakening dollar under Trump 2.0. The Fed's Nominal Broad U.S. Dollar Index has fallen 9% since Jan. 20, 2025, while previously derided currencies from the Mexican peso to the South African rand have surged.
The greenback remains 20% above its lows in the early 2010s, though, with little sign of improvement in yawning budget and current account deficits, notes Jae Lee, emerging markets local currency portfolio manager at TCW. "The dollar is still near the upper end of valuations," he argues. "But policy uncertainty is taking the shine off U.S. exceptionalism."
Emerging markets, once known for funny money and recurring balance-of-payments crises, have substantially flipped the macroeconomic script since the pandemic. They have tilted toward orthodox fiscal, and particularly monetary, policy while developed markets grow more profligate.
"Emerging market central banks have been more independent and effective at keeping inflation near target," says Carlos de Sousa, emerging markets debt strategist at Vontobel Asset Management. The result is "real yields"-the gap between bond yields and inflation rates-at or near double digits across much of Latin America.
The two global megaevents of the past year or so, the Iran War and artificial intelligence-driven capital investment spree, have been broadly positive for emerging market finances, argues Ed Al-Hussainy, global rates strategist at Columbia Threadneedle Investments.
Yields for prominent oil importers like India and Turkey have stabilized after an initial war-driven shock. Exporters of petroleum or metals, whose prices have soared on data center and semiconductor demand, are reaping a windfall. "This is a positive terms-of-trade shock like the early 2000s for Brazil, Peru, South Africa, or Zambia," he says.
Keirle points out a paradox within the emerging market local currency bond world. A big shift in the index toward more stable Asian economies has made the asset class as a whole less volatile. Current opportunity, though, is concentrated in traditional high-inflation, high-beta bad boys elsewhere.
Brazil is an across-the-board top pick despite octogenarian leftist Luiz Inácio Lula da Silva being favored to win a fourth term as president in October elections. Ten-year bond yields near 15% with inflation of less than 5%, plus rising oil receipts and a cheap-looking currency outweigh fear of Lula, TCW's Lee says. "Concerns in Brazil are around fiscal policy, but investors are getting paid for that," he argues.
Lee is also keen on South Africa, where the real yield on 10-year paper is more than 4% and exports rising on the strength of platinum and gold.
Short-term risks to the emerging market local currency bond story are largely external. Either definitive peace or boots-on-the-ground escalation in Iran could upset an oil market balance that both producers and consumers can more-or-less live with. Investors are more focused on chances that the Fed could return to a rate-hiking cycle, sucking capital back into U.S. paper.
Markets are pricing in two Fed hikes by early next year, T. Rowe's Keirle says. Chairman Kevin Warsh's hawkish-ish speech at Jackson Hole Aug. 28 raised the odds of faster tightening, without upending status quo assumptions yet.
If the Fed hikes more than expected, the party could be over," Al-Hussainy warns. "For now, it feels like a pretty good runway for EM."
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