In the fixed-income asset class Emerging market bonds are in the spotlight this year, boasting outstanding absolute performances. However, within the expansive Emerging market bonds universe, a remarkable trend has emerged: local currency bonds have surged ahead, delivering exceptional returns.
Notably, specific countries such as Colombia, Hungary, Brazil, and Mexico have delivered year-to-date returns ranging from 20 percent to a staggering 38 percent when calculated in USD. In contrast, their hard currency counterparts have only generated returns of approximately 5 percent each.
Promising Future for some local currency markets
Looking ahead, we firmly maintain our belief that local currency bonds in select countries will offer superior return opportunities compared to their hard currency counterparts. Our assessment is based on the following three reasons:
- Central banks in several countries, particularly in Latin America, have proactively initiated a cycle of interest rate hikes, raising nominal rates to double-digit levels.
- This proactive approach has resulted in positive real yields (nominal yields minus current inflation) — effective monetary policies that exert restrictions.
- A disinflationary trend is underway in numerous emerging market economies. In Brazil, for example, the inflation rate is less than 4 percent (as of May 2023). A year ago, it was still around 12 percent. This environment makes real yield valuations even more attractive and could even lead to interest rate cuts and consequently price gains on existing bonds in some cases in the coming quarters.
Countries to watch
Our assessment identifies Brazil, Mexico, Colombia, South Africa, and Indonesia as the ones offering the most favorable combination of the three reasons mentioned above. These nations have high nominal and real carry and the potential for additional interest rate cuts, making them prime candidates for attractive returns. As local currencies are currently stable in value, it should be possible to exploit most of the return potential. Additionally, this return potential basically applies to the fundamentally higher-quality segment within the emerging markets.