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Latin America Could Weigh on EM Bond ETFs in 2019

This article was originally published on ETFTrends.com.

A slew of factors are hampering emerging markets bond funds, including the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) , this year. One region in particular could be problematic for those funds in 2019.

EMB tracks the J.P. Morgan EMBI Global Core Index, a market-cap-weighted index. Potential investors should note that since it is a cap-weighted index, countries with greater debt will have a larger position in the portfolio. EMB, the largest emerging market fixed income exchange traded fund, is down more than 10% this year.

“Negative rating pressures emerged in several Latin American countries in 2018, and tightening external financing conditions, lukewarm and uneven growth, and persistent fiscal challenges and political risks will continue into next year,” said Fitch Ratings in a recent note.

Four of EMB's top nine geographic exposures are Latin American countries. That quartet is comprised of Mexico, Brazil, Colombia and Argentina. Five other Latin American countries are represented in the $14.97 billion ETF.

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“Six sovereigns in the region are currently on Negative Outlook/Watch (Argentina, Aruba, Costa Rica, Mexico, Nicaragua and Uruguay) versus three at the end of 2017. By comparison, only two have Positive Outlooks (Jamaica and Paraguay),” said Fitch. “In addition, we do not expect any speculative-grade sovereigns to reach investment grade in 2019. We expect the resolution of Venezuela's default to take a long time.”

Several emerging markets have been subject to credit rating downgrades or bearish outlook revisions this year. For example, Fitch downgraded Argentina’s credit rating while issuing two downward outlook revisions on embattled Turkey.

Related: Treasury Bond ETFs Are Rallying with Benchmark Yields Slipping Below 3%

Rising external financing costs and current account deficits are among the factors plaguing emerging markets debt this year. Some analysts and market observers believe the scenarios confounding emerging markets bonds this year could linger into 2019.

“While the overall growth environment is expected to improve somewhat, with regional GDP growth (excluding Venezuela) accelerating to 2.1% in 2019 versus an estimated 1.5% this year, downside risks persist. Brazil is expected to recover and Mexico's growth will remain relatively stable in 2019, but any disappointment with reforms and/or deterioration in the policy environment could undermine investor confidence and growth in both countries,” according to Fitch.

Mexico, Latin America's second-largest economy behind Brazil, is EMB largest geographic exposure. Those two countries combine for over 9.5% of the fund's weight.

“Tougher external financing conditions will continue to be a macroeconomic theme for the region next year and will be a greater challenge for countries with larger current account deficits, limited FDI, weak liquidity and high US dollar-denominated government debt,” said Fitch.

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