2016 was a good year; 2017 may see headwinds
Kevin Daly, Aberdeen Asset Management’s portfolio manager on the emerging market debt team, sees treasury yields rising in the US, thereby serving as a headwind to emerging market bonds. 2016 was a rare year for emerging market bonds delivering about 10% return. The emerging market debt tracking iShares JPMorgan USD Emerging Markets Bond ETF (EMB) has returned about 8.5% over the past year. The PowerShares Emerging Markets Sovereign Debt Portfolio ETF (PCY) and the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC) also delivered 8% returns each over the past year.
Two headwinds for emerging markets bonds in 2017
Daly, however, doesn’t see this rally continuing, and highlights two headwinds for emerging market bonds in 2017. These are:
- Emerging market bond yields have come down a lot since last year, as treasury yields have begun to rise in the US (SPY) (IWM).
- The markets are expecting the Fed to hike interest rates at least twice this year (while the Fed has signaled three hikes). Moreover, the US economy is near full employment. There are also prospects for inflation rising, not just from wage pressures, but from corporate and income tax cuts. So, this year, the Fed could be more aggressive than the markets expect. All this would serve as a headwind for emerging market bonds this year.
The only situation brightening the prospects for emerging market debt would be if Donald Trump’s policies fizzle out, or the expected tax cuts don’t happen. In all, Daly expects 2017 to be a “tricky year” for emerging market bonds.