Goldman argues that dollar debt will outperform as potential US election volatility bolsters the greenback and leads to policy changes that could hurt developing-nation assets. Fidelity says local-currency assets will perform better as the Federal Reserve starts to cut interest rates.
The clash between two of the top global financial firms mirrors the growing uncertainties that lie ahead for investors due to the tumultuous US presidential vote in November, and the debate over how fast the Fed will ease monetary policy.
“Total returns of emerging-market dollar bonds are likely to prove more resilient than local-currency EM bonds as we move through the remainder of the year,” said Kamakshya Trivedi, head of global foreign-exchange and interest rates at Goldman Sachs in London.
“Even a benign macro markets outlook and Fed cuts are likely to increasingly take a back-seat to the US elections – which may potentially re-set the policy landscape in a way that is unfriendly to EM local currency assets,” he said.
Emerging-market dollar bonds have outpaced their local-currency peers this year, returning about 4.3% versus 1.4%, according to Bloomberg indexes. While both gauges have seen similar returns from price appreciation and coupon payments, the local bonds have been dragged down by a currency loss of 3.2%.
Goldman’s Trivedi says emerging-market local bonds may see some support from the recent disinflationary trend, but the fact that a number of their central banks have already cut rates means there’s less room for further easing ahead.
“With EM central banks deeper into their cutting cycles, this backdrop may not provide much comfort for the asset class in the second half of the year given the potential headwinds that may emanate from US-election related volatility,” he said.
Fidelity’s View
For its part, Fidelity says local bonds are likely to beat their dollar-based peers as Fed rate cuts weigh on the dollar. Another positive is that elections in some of the largest emerging countries that were an earlier source of concern, have been successfully navigated.
“With the Fed soon to commence its easing cycle, the stars are aligning for EM rates and FX to perform better,” said George Efstathopoulos, a portfolio manager at Fidelity in Singapore. “EM local election-risk premia has subsided now that index heavyweights such as Indonesia, India, Mexico have already gone through their election cycles.”
A number of emerging-market economies have become more resilient due to their better growth and inflation outlooks, improving debt profiles and a lower proportion of external debt — making them less vulnerable to dollar fluctuations, Efstathopoulos said.
Goldman isn’t alone in favoring dollar-denominated debt.
“I favor EM hard-currency bonds due to their lower currency risk,” said Rajeev De Mello, a global asset portfolio manager at Gama Asset Management in Geneva. “As we enter an uncertain US election season, I anticipate an increase in market volatility, further supporting the defensive nature of EM hard-currency bonds.”
A Donald Trump election victory may lead to great protectionism as the former president has said he may impose tariffs of 60% on imports from China, and 10% duties on the rest of the world. Trump has also pledged to cut taxes, raising the prospect of a higher US fiscal deficit and Treasury yields, that may boost the dollar.
“Emerging markets could face challenges if US protectionism increases,” Gama’s De Mello said. “This could lead to a depreciation of EM currencies and force EM central banks to maintain policy rates at higher levels than they would otherwise.”
NatWest Markets Plc agrees the US election could be challenging for emerging market local-currency debt.
“We are yet to know Trump’s full economic agenda so most traders are left using Trump’s 2017 first presidential term as a playbook for any second term,” said Eimear Daly, an emerging-market strategist at NatWest Markets Plc in London. Traders will be particularly wary over taking exposure in currencies such as the Mexican peso and Chinese yuan, she said.