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4 charts on reasons to consider EM local currency bonds
Harry Phinney
Fixed Income Investment Director
Joseph Dowd
Senior Product Specialist
June 7, 2021

As emerging markets matured over the last couple of decades, many countries began issuing bonds denominated in their respective local currencies rather than U.S. dollars. This has created a valuable sub-asset class worth more than $3 trillion alongside U.S. dollar-denominated emerging markets debt. Given projections for U.S. deficit growth and the potential for sustained U.S. dollar weakness, we believe now is a good time for institutional investors to consider their allocations to this large and growing segment of the emerging markets debt universe.


In our view, EM local currency bonds can offer an attractive risk-reward trade-off for investors seeking a high level of current income and U.S. dollar diversification. Countries that issue local currency debt tend to have independent central banks, developed yield curves and investment-grade credit ratings.


Here are four reasons to consider investing in EM local currency bonds in diversified portfolios.


1. The universe for emerging markets debt has changed significantly over the last 20 years


Local currency bond issuance has increased significantly since the early 2000s and is now the predominant issuer base within the asset class. It also represents the greatest degree of depth within fixed income emerging markets and benefits from a broad investor base consisting of foreign investors, local governments, pension funds, banks and other domestic investors.


Issuance has soared as economies have matured

Chart shows the growth of both the U.S dollar-denominated emerging markets debt market, as represented by the J.P. Morgan EMBI Global Bond Index, and the local currency-denominated emerging markets debt market, as represented by the J.P. Morgan GBI-EM Broad Index, from 1995 through 2020. Since the launch of the local currency index in 2002, this sub-asset class has grown meaningfully relative to the U.S. dollar index. As of December 31, 2020, the local currency emerging markets debt market stood at approximately $3.4 trillion, compared with $1.3 trillion for the U.S.-dollar denominated market. Together, the two sub-asset classes totaled nearly $4.7 trillion. Source: J.P. Morgan.

Source: J.P. Morgan. Emerging markets U.S. dollar-denominated sovereign bonds represented by J.P. Morgan EMBI Global Bond Index; emerging markets local currency sovereign bonds represented by J.P. Morgan GBI-EM Broad Index. Data as of December 31, 2020.

2. Local currency bonds provide U.S. dollar diversification


Emerging markets currencies allow investors to diversify their U.S. dollar exposure within a broader portfolio. Moreover, diversified allocations to these currencies can provide an opportunity to benefit from potentially stronger global economic growth, which has historically coincided with appreciation in their value relative to the U.S. dollar.


Emerging markets currencies can provide U.S. dollar diversification

Line graph reflecting the foreign exchange price of the U.S. dollar, represented by the Bloomberg Dollar Spot Index, and a basket of emerging markets currencies, as represented by the J.P. Morgan Emerging Local Markets Index Plus from 2004 to March 31, 2021. There is a demonstrated track record that reflects the diversification opportunity emerging markets currencies can offer to a U.S. dollar-denominated portfolio. Sources: Bloomberg, J.P. Morgan.

Sources: Bloomberg, J.P. Morgan. U.S. dollar FX is represented by the Bloomberg Dollar Spot Index; emerging markets FX is represented by the J.P. Morgan Emerging Local Markets Index Plus. Data as of March 31, 2021.

3. Emerging markets local currency bonds can provide a high level of current income


Emerging markets local currency debt has at times provided a higher yield than its U.S. dollar-denominated counterpart. Both have provided a meaningful pickup in yield over U.S. core bonds. A recovery in global economic growth could be supportive of the asset class and may benefit emerging markets currencies in particular over the longer term.


Emerging markets local currency and U.S. dollar bonds have provided a meaningful pickup in yield over U.S. core bonds

Line graph reflects the monthly yields of U.S. dollar emerging markets debt, as represented by the J.P. Morgan EMBI Global Diversified Bond Index, local currency emerging markets debt, as represented by the J.P. Morgan GBI-EM Global Diversified Bond Index, and U.S. core bonds, as represented by the Bloomberg Barclays U.S. Aggregate Index from 2004 to March 31, 2021. Over this period, local currency emerging markets debt provided higher yields than dollar-denominated emerging markets debt approximately 78% of the time. The most recent exception was in the final 11 months of 2020 at the onset of the pandemic, but the historical trend of local currency emerging markets debt yields surpassing those of their dollar-denominated counterparts returned in the first three months in 2021. Both U.S. dollar emerging markets bonds and local currency emerging markets bonds have notably provided higher yields than U.S. core bonds over all periods. Sources: J.P. Morgan, Bloomberg.

Sources: J.P. Morgan, Bloomberg. U.S. dollar EM debt represented by J.P. Morgan EMBI Global Diversified Index; local EM debt represented by J.P. Morgan GBI-EM Global Diversified Bond Index; U.S. core bonds represented by Bloomberg Barclays U.S. Aggregate Index. Yield to maturity is the rate of return anticipated on a bond if it is held until the maturity date. Data as of March 31, 2021.

4. A weaker dollar typically benefits emerging markets local currency bonds


Given relatively low yields in the U.S. coupled with “twin” (fiscal and current account) deficits that are expected to grow, it is reasonable to believe the U.S. dollar is likely to move into a period of longer term decline. This could meaningfully benefit emerging markets bonds and currencies. Although both local currency and dollar-denominated emerging markets bonds have historically provided strong results when the U.S. dollar was weak or weakening, local currency debt has typically added significantly more value.


Local currency debt has added value in periods of U.S. dollar weakness

Bar chart compares the cumulative returns for local currency emerging markets debt and U.S. dollar emerging markets debt during periods of U.S. dollar weakness, as represented by periods when the Bloomberg Dollar Spot Index declined by more than 10%. In five different periods since the mid-2000s, both local currency and U.S. dollar emerging markets debt significantly outpaced the spot price of the dollar. Additionally, local currency emerging markets debt outpaced the results of U.S. dollar emerging markets debt, with the one exception from March 2020 to December 2020, when dollar-denominated emerging markets debt outpaced local currency debt by 40 basis points. Sources: Bloomberg, J.P. Morgan.

Sources: Bloomberg, J.P. Morgan. U.S. dollar-denominated emerging markets debt represented by the J.P. Morgan EMBI Global Diversified Index; local currency emerging markets debt represented by the J.P. Morgan GBI-EM Global Diversified Index. Reflects cumulative results during periods when the Bloomberg Dollar Spot Index declined by more than 10%. Data as of March 31, 2021.

The bottom line: Emerging markets local currency bonds have provided U.S. dollar diversification and a high level of current income, and have historically added significant value during most periods of U.S. dollar weakness. For these reasons, investors may want to consider this asset class when making asset allocation decisions within their broader portfolios.


Harry Phinney is a fixed income investment director with 18 years of industry experience (as of 12/31/23). He holds an MBA in international business from Northeastern University, a master’s degree in applied statistics and financial mathematics from Columbia University and a bachelor’s degree in international political economy from Northeastern University. 

Joseph B. Dowd is a senior product specialist with 11 years of industry experience (as of 12/31/20). He holds an MBA from the Marshall School of Business at the University of Southern California and a bachelor's degree in political science from University of California, Riverside. 

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J.P. Morgan Emerging Markets Bond Index – Global tracks total returns for U.S. dollar-denominated debt instruments issued by emerging markets sovereign and quasi-sovereign entities, including Brady bonds, loans and eurobonds. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of account fees, expenses or U.S. federal income taxes.

 

J.P. Morgan Government Bond Index – Emerging Markets Global Diversified covers the universe of regularly traded, liquid fixed-rate, domestic currency emerging market government bonds to which international investors can gain exposure. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of account fees, expenses or U.S. federal income taxes.

 

The Bloomberg Dollar Spot Index tracks the performance of a basket of 10 leading global currencies versus the U.S. dollar. It has a dynamically updated composition and represents a diverse set of currencies that are important from trade and liquidity perspectives.

 

The J.P. Morgan Emerging Local Markets Index Plus Index tracks total returns for local currency-denominated money market instruments in emerging market countries. Local market FX performance is measured by capturing returns in the deliverable and non-deliverable FX markets for each member country.

 

The J.P. Morgan Emerging Market Bond Index (EMBI) Global Diversified is a uniquely weighted emerging market debt benchmark that tracks total returns for U.S. dollar-denominated bonds issued by emerging market sovereign and quasi-sovereign entities. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of account fees, expenses or U.S. federal income taxes.

 

J.P. Morgan Government Bond Index – Emerging Markets Global Diversified covers the universe of regularly traded, liquid fixed-rate, domestic currency emerging market government bonds to which international investors can gain exposure. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of account fees, expenses or U.S. federal income taxes.

 

Bloomberg Barclays Global Aggregate Index represents the global investment-grade fixed income markets. This index is unmanaged, and its results include reinvested distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes.

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