Higher Yielding Emerging Markets: Missed the Boat?

The recovery of commodity prices last year helped to improve the currency fortunes of emerging market (EM) economies, including Russia, Brazil, and South Africa. This provided a benign dynamic of currency appreciation and lower inflation, opening the way to lower interest rates. These trends extended through the first half of this year, helped by the decline in the US dollar and government bond yields in most developed markets since the end of the first quarter.

What’s left on the table for investors in higher yielding EM local currency markets? One potential threat is the outlook for higher US interest rates and a resurgence of the dollar but Fed tightening is likely to proceed with caution and not rock the boat. Another potential worry is the recent drop in the price of oil and geopolitical risks remain in the background.

Common economic factors have been at play across EMs but independent political and economic risk factors also make the case for differentiation. We examine whether attractive opportunities remain for global bond investors. Mexico still offers the best potential for lower yields, but the prospect for further gains is limited. Relatively high inflation will inhibit any early scope for rate cuts. Moreover, political worries remain in the background and could grow before next year’s general elections.