Fund managers are still sticking to a popular emerging market investment strategy in early 2024, even though the strategy suffered setbacks in the first five months of the year.

According to foreign media data, local bonds in emerging markets were affected by rising long-term US interest rates and the strength of the US dollar. The Bloomberg (Emerging Markets) Local Bond Index is down 1.1% so far this year, while the hard currency debt index is up 1.2%.

However, for Grantham Mayo Van Otterloo & Co.'s Victoria Courmes, local bond trading in emerging markets is far from over. In January, she hailed emerging market local bonds as a “once-in-a-lifetime” opportunity. In fact, emerging market local bonds are more attractive than before, she said.

Courmes said, “Interest rates remain high, and the gap with the real yield on US Treasury bonds widens further. Interest rates in emerging markets seem more attractive.”

Emerging market local bonds did not perform as well as US bonds

Last week, there was a clear shift among emerging market policymakers. The Bank of Brazil cut the benchmark interest rate by only 25 basis points, ending six consecutive 50-basis point rate cuts — a move that has prompted analysts to raise their year-end interest rate forecasts. The Bank of Mexico, on the other hand, kept interest rates unchanged and suspended action after cutting interest rates in March, while Malaysia also chose to keep borrowing costs stable in response to the risk that US interest rates may be high for a long time and market fluctuations will increase.

The central bank of Romania set borrowing costs late Monday, which is another case of observation. Although “cutting interest rates a few weeks ago seemed like a foregone conclusion,” ING Groep NV economist Valentin Tataru pointed out that there are now reasons to be cautious.

Strategy “Metamorphosis”

With the resilience and stubborn inflation shown by the US economy, the market lowered expectations that the Federal Reserve would cut interest rates in 2024. Coupled with the strengthening of the US dollar, the strategy of investing in US bonds was reversed. The Bloomberg dollar index has risen 3.4% this year, in stark contrast to the 2.7% decline in 2023.

The subsequent depreciation of emerging market currencies prompted many investors to abandon emerging market local debt transactions. According to Bloomberg data, as of May 3, the $2.8 billion VanEck JP Morgan Emerging Markets Local Bond ETF had outflows for four consecutive weeks. This is the longest continuous outflow record since the COVID-19 outbreak in March 2020.

Carlos de Sousa, an investor in Vontobel Asset Management, said, however, that the US economy is showing initial signs of cooling — a slowdown in employment growth and an unexpected rise in unemployment, which may ease pressure on interest rates and may weaken the dollar.

“We may be closer to that turning point,” de Sousa said. The probability that such a scenario will end up being realized is slightly higher than a few months ago.”

Emerging market local bond ETFs have experienced outflows for four consecutive weeks

The hesitation he showed reflected the general cautious sentiment of investors. The market generally expected the dollar to weaken at the beginning of the year, but in the face of America's highest inflation and interest rates in decades, as well as global geopolitical conflicts, this expectation has been forced to be re-evaluated.

Pictet's fund manager Chris Preece stated, “We are still in the dollar cycle, which is characterized by American exceptionalism — relatively strong growth and hawkish monetary policies, and global conflicts, all of which make up a virtuous circle for the dollar.”