EM Local-Currency Bonds Outperform Dollar Debt by 3 Points

Local-currency emerging market bonds outperformed their dollar-denominated counterparts by more than three percentage points since late June. This gap positions local debt for its largest quarterly advantage since 2022, according to Bloomberg data.

Investors are rotating toward local debt due to cheaper valuations and attractive carry trades. The shift is evident in recent fund flows, positioning surveys, and relative performance metrics reported by Briefs Finance.

Manager Allocations Shift Toward Local Debt

Bank of America’s survey of 38 fixed-income managers covering $444 billion shows a major tilt. Eighty-four percent now allocate more to local-currency EM debt than to hard-currency bonds, up from 38% in August.

Robeco’s Diliana Deltcheva cited current valuations as the primary driver for this preference. She noted that spread tightening opportunities in hard-currency bonds appear increasingly limited compared to local markets.

Dollar Strength Poses Key Risk

The 120-day correlation between local EM bonds and the dollar index is -0.51, the most negative in a year. A stronger dollar could sap demand for local assets, especially after the Federal Reserve raised rates.

The dollar index rose 1.1% last week, its largest gain since early June. Jupiter Asset Management warned that higher Treasury yields could strain weaker sovereign and corporate issuers in EM hard-currency debt.

ETF Flows Reflect Investor Preference

The VanEck JPMorgan EM Local Currency Bond ETF attracted $41 million this month. This follows a $294 million inflow in August, highlighting sustained demand for local-currency exposure.

EM dollar debt spreads over Treasuries sit at 1.69 percentage points, near 20-year lows. The 10-year Treasury yield hit a two-decade high ahead of the Fed’s recent rate hike, driven by sticky inflation.