Emerging Market Debt Sees Surge in Local Currency Bonds

Emerging Market Debt Sees Surge in Local Currency Bonds

Emerging market investors are turning their attention to local currency-denominated bond instruments while moving away from dollar-based debt, according to data provided by EPFR Global, a fund flow and allocation data provider. The surge in interest is attributed to the impressive performance of currencies like the Brazilian real and the Mexican peso, which have experienced significant appreciation against the US dollar.

Investors Abandon Dollar-Based Debt for Local Currency Bonds

The trend of investors fleeing from dollar-denominated debt in favor of local currency bonds is gaining momentum within the emerging market debt landscape. EPFR Global, a fund flow and data allocation provider, reveals a substantial shift in monetary flows, with investors withdrawing USD 2.65 billion from US dollar-denominated emerging market bonds during the first four months of the year while allocating USD 5.23 billion to local currency-denominated debt within the same period.

Experts anticipate that this shift will persist as the dollar's strength is threatened by potential debt defaults and interest rate volatility. Paul Greer, an emerging markets debt portfolio manager at Fidelity International, expresses confidence in the continued outperformance of local markets over external debt, stating:

"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, highlights the attractiveness of local currency debt from a fundamental and valuation standpoint.

"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."

Dollar-Denominated Bonds Lose Appeal as Local Currencies Gain Strength

The decision to abandon dollar-denominated bonds in favor of local currency alternatives stems from several factors. One key factor is the appreciation of certain local currencies against the US dollar, such as the Mexican peso and the Brazilian real, which have both seen more than a 10% increase in value. Additionally, proactive measures taken by the central banks in emerging economies, including interest rate hikes to combat inflation, have enhanced the real yield offered by these bonds. Notably, Brazil and Mexico have seen their interest rates rise to 13.75% and 11.25%, respectively, accompanied by inflation rates of 4.15% and 5.3%.

However, some analysts caution that market confidence remains low, leading investors to hoard cash while awaiting signals to reinvest in these instruments.

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