Emerging-market bonds are attractive as their value already reflects “a good chunk of the risks” stemming from interest-rate increases from the Federal Reserve, according to Pacific Investment Management Co.
“On balance, we believe emerging markets are well- positioned to weather the Fed tightening cycle,” Michael Gomez, head of emerging-market portfolio at Pimco in Newport Beach, California, wrote in a blog post. “Barring fresh bad news, we expect investors will look increasingly to EM for higher yield and carry, which should additionally support EM currencies.”
Emerging-market dollar-denominated debt and most currencies have gained since U.S. policy makers raised borrowing costs on Wednesday for the first time since 2006.
Developing-nation dollar debt yielded 4.2 percentage points above U.S. Treasuries, up from 3.5 percentage points at the end of 2014, according to data compiled by JPMorgan Chase & Co. At 7.1 percent, yields on local-currency bonds are 5.4 percentage points higher than five-year U.S. Treasuries.
While Fed rate increases in the past have contributed to emerging-market crises, developing nations are more resilient because governments have accumulated $7 trillion in foreign reserves, switched away from dollars for funding and allowed their currencies to fluctuate, Gomez wrote.
Global investors are underweight emerging markets, reducing the risk of further selloffs, he said.
Investors need to be selective because some nations still depend on global debt markets for funding, leaving them more vulnerable to risk sentiment, Gomez said. Companies borrowed “heavily” in recent years, suggesting governments may potentially need to bail them out and damage the balance sheets of the sovereigns.
“Country and credit selection are paramount,” Gomez wrote.