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Why EM Bonds are Topping Expectations

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This article was originally published on ETFTrends.com.

The dollar's recent resurgence has plagued several asset classes, including emerging markets debt. With the greenback rising, that means other currencies are slumping, including developing world currencies. That scenario is weighing on emerging markets bonds denominated in local currencies.

A stronger dollar raises external financing costs for developing economies and usually leads to lower commodities prices, a relevant point because many developing commodities are major commodities exporters.

The VanEck Vectors Emerging Markets Local Currency Bond ETF (EMLC) is off nearly 6% year-to-date. EMLC is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

“As emerging markets local debt lost more than 8% since the beginning of April and moved into negative territory for the year, there were some powerful reminders of the sources of volatility that can appear among the geographically, economically, and politically diverse landscape of emerging markets,” said VanEck in a recent note. “As always, we saw volatility stemming from both internal and external factors.”

The $5.2 billion EMLC follows the J.P. Morgan GBI-EMG Core Index, “which is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer,” according to VanEck.

Not Over Yet for Emerging Markets

While emerging markets assets have been stymied by the stronger dollar, some investors believe the emerging markets trade has not expired. The global economy continues expanding and growth in China, the largest emerging markets, is topping expectations.

“Appropriately, additional risk has been priced into struggling markets, such as Turkey (our definition of an emerging market is one whose currency weakens and rates rise in periods of market stress or when the market believes the country has misstepped (e.g. a policy mistake or undesirable political dynamics),” said VanEck.

Some of the developing economies that have recently been most confounded by macro economic woes, such as Argentina and Turkey, are not major parts of EMLC's roster. Those two counties combine for just over 7% of the ETF's geographic exposure.

“Emerging markets economies remain both a driver of, and beneficiary of, a benign global growth environment. Many, but not all, continue to benefit directly from higher commodity prices – a trend that has remained in place as emerging markets sold off,” adds VanEck.

EMLC has a 30-day SEC yield of 6.15%.

For more information on the fixed-income markets, visit our bond ETFs category.

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