"US Economy Strong, Unlikely to Rush Interest Rate Cuts"
Last month, the United States lowered its benchmark interest rate for the first time in four and a half years, and as expectations grow that the rate will be reduced slowly, emerging market bonds are once again experiencing sluggishness. Risk assets such as emerging market bonds attract attention only when the global funding environment improves.
According to Bloomberg on the 20th (local time), despite the U.S. Federal Reserve (Fed) deciding to cut interest rates for the first time since March 2020 last month, emerging market bond yields have posted their worst performance since February 2023 over the past month. The average yields of emerging market dollar-denominated bonds and emerging market local currency bonds both recorded 0.09% (1bp = 0.01 percentage points) since the 18th of last month.
Previously, global asset management firms such as PIMCO and Nuveen Berman anticipated the U.S. benchmark rate cut and competitively increased their investment allocations to emerging market bonds. The U.S. benchmark rate cut was expected to enhance the investment appeal of these markets.
However, as strong indicators supporting the robust U.S. economy have been released consecutively, spreading the view that the Fed will not rush to cut rates, there has been an analysis that demand for emerging market bonds has decreased. According to the Chicago Mercantile Exchange Group's FedWatch tool, just a month ago, the probability of the Fed making a big cut in November exceeded 50%, but as of this date, it reflects only 0.7%.
As a result, the U.S. dollar has strengthened again, and in the case of emerging market local currency-denominated bonds, investors are even experiencing foreign exchange losses.
Some emerging market governments are still hesitant to decide on rate cuts, which also diminishes the attractiveness of emerging market bonds. For example, T?rkiye maintained its rate at 50.0% this month, deciding to hold steady for the seventh consecutive month. After the U.S. rate cut, the general consensus is that emerging markets need to lower their rates consecutively for capital to flow into these markets.
Meanwhile, the rising probability of former President Trump, the Republican presidential candidate, winning the election is increasing the risk premium on emerging market bonds. Many economists believe that if a second Trump administration begins, exports from developing countries could decline.
Anders Færgeman, Chief Portfolio Manager at PineBridge Investments, pointed out, "The rally in the U.S. dollar and emerging markets' cautious stance on monetary easing likely triggered profit-taking in emerging market local currency bonds."
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