The impact of rising US interest rates on emerging market bonds

Emerging market (EM) bonds have delivered decent performance in 2017 and a number of factors should continue to support sentiment towards the asset class.

These include the higher yields available from EM bonds relative to their developed market counterparts, as well as the diversity of both the emerging market governments and corporate bond universes.

At the same time, looking ahead of next year, the relevant risks need to be assessed closely, such as rising US interest rates, although EM debt markets should continue to be able to withstand a slow and gradual tightening path from the Federal Reserve. Also, for a number of emerging economies, the higher US rate environment is less challenging than it would have been a few years ago, largely due to factors such as the improvements they have made to their current accounts, as well as adjustments towards having lower overall levels of US dollar-denominated debt. However, rising US interest rates can cause a headwind for other emerging economies, particularly those that are more reliant on US dollar funding such as Turkey.

More supportively for the asset class, as economic growth forecasts edge upwards across most developed and developing countries, the credit quality of EM bond issuers should stabilise as EM credit ratings actions tend to correlate with growth rates.

Looking ahead of next year higher yielding, less liquid African issuers look compelling as well as a number of Latin American countries benefiting from rising commodity prices and having inflation under control including Brazil, Argentina and Peru.

Claudia Calich – fund manager, M&G Emerging Markets bond – M&G Investments