Emerging Market Bonds, on a Roll, Should Do Even Better, Says Ned Davis

Emerging market bonds have done well over the past year and will continue outperforming “in coming months,” according to a report from Ned Davis Research.

Since early 2023, the bonds of these developing nations, both sovereigns and corporates, have outpaced the Bloomberg Global Aggregate and the U.S. Agg. The prospect of a somewhat weaker dollar, once the Federal Reserve finally cuts interest rates, would further fuel EM bonds, reasoned Joseph Kalish, chief global macro strategist at Ned Davis, in the report.

EM bonds’ total return outpaced that of the global Agg by 2.7 percentage points this year, up from 2.1 points in 2020, the low for this decade. Some of this has come from a rebound in commodity prices—and raw materials are a big deal for EM economies—but growth in manufacturing and other non-commodity sectors is increasingly important for developing countries.

In addition, Kalish observed, “The fact that EM has been able to outperform in the face of a firm U.S. dollar is a testament to its underlying strength.” A strong dollar historically has hindered EM economies because they need outside capital. This capital is harder to come by when it is rushing into U.S. investments to take advantage of higher rates that usually result from a robust greenback.

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But if U.S. rates decrease, as is widely anticipated, that typically would weaken the buck. The probability of dollar depreciation in the near future is around 75%, with a modest decline of 1.1% annualized as the most likely outcome, per an analysis by the Vanguard Group.

Also helping EMs are low defaults on their fixed-income securities. According to the Ned Davis report, this shows up in the low pricing to insure EM bonds. In the past year, the spreads between bond prices and those of credit default swaps have narrowed by half, the Davis paper pointed out.

Once the Fed eases, expectations are that EM central banks will follow, aiding their economies’ growth. The Central Bank of Brazil, for instance, already has cut the benchmark Selic rate by a half-point to 10.75% in March. That reduction is aimed at bolstering economic growth in Brazil.

Among the biggest winners have been Indian bonds. Over the past 12 months, the S&P BSE India Bond Index has climbed 7.2%. The Bloomberg U.S. Agg, covering Treasurys and investment-grade corporates, is up just 2.5% for the period.

Indian bonds stand to improve still more, as the Reserve Bank of India is poised to cut rates (although it likely will wait until after the Fed decreases them, a Bloomberg survey of economists found). While other EM currencies have slumped in the face of a strong U.S. dollar, India’s currency has not, owing to a very optimistic outlook for its economy, which is up over 8% yearly.