Emerging markets investors are being attracted by local currency-denominated bond instruments while leaving dollar-denominated debt, according to data provided by EPFR Global, a fund flow and allocation data insights company. These markets have outperformed dollar-denominated debt due to the behavior of currencies like the Brazilian real and the Mexican peso, which have appreciated against their U.S. counterpart.
Emerging Market Debt Investors Flee to Local Currency Bonds
Investors in emerging market debt have taken interest in local currency-denominated instruments, while abandoning dollar-based bonds, according to data provided by EPFR Global, a fund flow and allocation data provider. Numbers indicate that monetary flows have moved from bonds denominated in hard currency to local currency bonds, given that these have outperformed their dollar-denominated counterparts.
EPFR Global found that during the first four months of the year, investors withdrew $2.65 billion from emerging market bonds denominated in U.S. dollars. During the same period, the money flows to local currency-denominated emerging market debt rose by $5.23 billion.
Analysts believe this move will continue, as the strength of the dollar is being threatened by a possible debt default and interest rate volatility. Paul Greer, emerging markets debt portfolio manager at Fidelity International, stated:
Local markets are far outperforming external debt. Frankly, I think that trend will probably continue for the rest of the year.
Similarly, Thanos Papasavvas, chief investment officer at ABP Invest, stated:
We have seen a clear divergence between emerging market local and hard currency bonds over the past few quarters with local currency debt looking more attractive on a fundamental and valuation basis.
Reasons for Abandoning Dollar-Denominated Bonds
There are several reasons for this trend. First, some local currencies have appreciated compared to the U.S. dollar. This is true for the Mexican peso and the Brazilian real, which have appreciated more than 10% against the U.S. dollar.
Also, the early actions of some central banks in emerging countries, which raised their interest rates due to inflation, have improved the real yield that some of these bonds offer. Brazil and Mexico are examples of this again, with the former having an interest rate of 13.75% and year-over-year inflation of 4.15% in May, and the latter having an 11.25% interest rate compared to a 5.3% inflation rate in April.
However, other analysts state that confidence in the market is very low and that investors are hoarding cash waiting for signals to start putting funds in these instruments again.
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