Emerging Markets: Selectivity key as Fed path clouds – HSBC

HSBC Asset Management highlights that local-currency bonds from emerging markets have generated strong returns over the past four years, bolstered by credible policies and appealing real yields. However, year-to-date performance has cooled as U.S. Treasury yields have increased and the differential between emerging market and U.S. real rates has shrunk.

The firm maintains that the strategy for investing in EM local debt remains viable, but anticipates that the next phase will be more dependent on country selection rather than broad beta exposure.

Emerging market local-currency bonds have delivered solid returns over the past four years, aided by improved credibility of policies, attractive real yields, and robust macroeconomic conditions. Yet, momentum has slowed down this year. Heightened uncertainty surrounding the Federal Reserve's policy trajectory has led to higher long-dated U.S. Treasury yields, while the spread between EM and U.S. real interest rates has narrowed in numerous markets.

This reduced room for additional policy easing has limited the upside potential for EM bond performance.

On a positive note, several Latin American markets, including Brazil and Mexico, entered this cycle with robust inflation-fighting measures after tightening policies early in 2021-2022, providing their central banks with more flexibility as inflation eases. Conversely, certain regions in Asia, particularly Thailand and the Philippines, confront a more challenging policy dilemma as inflation concerns persist.

The strategic value of EM local debt continues to hold, but the subsequent stage of the cycle should benefit from selective investment, with future performance hinging more on country selection than on broad exposure.