(Bloomberg) -- Global investors are the most upbeat in six years about emerging-market sovereign dollar bonds, whether the Federal Reserve cuts interest rates or not.
In the past two months, as monetary-easing expectations ran high after the Fed’s outsized cut, the bonds outperformed Treasuries. And now, as fears of “higher-for-longer” rates resurface, the bonds continue to beat US government debt, this time helped by renewed strength in the dollar.
That means risk premiums are shrinking. The extra yield investors demand to leave the safety of Treasuries and own EM dollar bonds has fallen to the lowest level since April 2018, according to a Bloomberg index. A similar measure from JPMorgan Chase & Co. shows the spread has narrowed in nine of the past 10 weeks.
“A combination of Fed easing and robust economic growth reassures markets that most countries and corporates will pay,” said Anders Faergemann, a senior portfolio manager at Pinebridge Investments in London. “Combining market access with decent growth prospects is a very good cocktail.”
US Treasury yields, on average, have increased 18 basis points since Aug. 5, when global markets were plunged into turbulence amid an unwind of carry trades funded by the Japanese yen. In this period, the average yield on the Bloomberg Emerging Markets Sovereign Total Return Index has fallen 70 basis points.
The options-adjusted spread on the index stands at 277 basis points, a drop from 372 basis points. The JPMorgan spread has shed 80 basis points in the period.
Traders had bet on the Fed continuing to decrease borrowing costs rapidly after the Sept. 18 cut, only to pull back those expectations after a strong US jobs report last week revived concern inflation could reignite.
Traders now see about 50 basis points of easing by the end of the year, with less than 150 basis points priced through October 2025. That’s down from expectations for about 200 basis points of reductions in late September.
The resilience of EM dollar bonds contrasts with stocks and local-currency bonds in the developing world, which have been whipsawed by changing Fed wagers. Even though local bonds are seen as a candidate for outperformance in the monetary-easing era, the recent turbulence has kept a lid on them. A Bloomberg index for the asset class has fallen for seven successive days, the longest streak since June 2022.
“While EM local bonds remain attractive, the strong US labor report suggests there is still a degree of strength in the US economy that we don’t see in Europe or China, removing some of the downside risk to the US dollar,” Faergemann said.
If expectations for more measured rate cuts by the Fed come true, that would underpin strength in the greenback and take some “shine off” local bonds, he said.
Since the Fed cut on Sept. 18, high-yield bonds have posted some of the biggest gains in the Bloomberg dollar-bond index. Sri Lanka, where the newly elected leftist president reaffirmed commitment to an International Monetary Fund program, handed investors 11% returns. Argentina, where President Javier Milei has unveiled a reform program aimed at fiscal discipline, deregulation and trade openness, El Salvador, where the government announced a buyback, and Lebanon were among the other outperformers.
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