Emerging market local currency sovereign bonds issued in “currencies that people can trust” are currently the best fixed income products, according to García Zamora, who is the leader of the emerging market debt team at Standish Mellon, a specialist asset management boutique under BNY Mellon.
García Zamora is the co-manager of the BNY Mellon Emerging Market Debt Local Currency Fund.
“Their valuations are more attractive [and the exchange rate] context is very constructive,” he said. “If the dollar goes down, emerging markets currencies will go up and the returns of local currency bonds in dollar or euro terms will be more attractive than those of hard currency bonds”.
(In this view, he agrees with BNP Paribas’ Guillermo Felices).
In the “local currency universe”, he includes Indonesia, Malaysia, Singapore, Thailand and Philippines, as well as some Eastern European and South American countries.
Local currency sovereign bonds are more attractive than hard currency in part thanks to their liquidity.
“Liquidity can be more challenging” in hard currency bonds issued by emerging market countries, in particular in the Middle East, Africa, Central America and Asia, he noted.
India and China in particular belong to the hard currency universe because they restrict the ability of foreigners to access their local currency bond markets, García Zamora said.
The hard currency category includes between 10% and 25% of corporate bonds in the firm’s strategy.
Avoiding Eastern Europe
Despite including Eastern Europe (Poland, Hungary, Romania and Czech Republic) in his “local currency universe” García Zamora is less interested in the region’s bonds. These countries, he said, “are very ingrained in the production chain of the Eurozone, especially Germany. They are suffering from a similar phenomenon as Germany, where inflation is essentially very low and central banks have been cutting rates for many years”.
“As inflation in the Eurozone rebounds higher, inflation in these countries will pick up too and the central banks will have to increase rates,” he added.
On the other hand, García Zamora expects countries like Brazil, Russia, Argentina or South Africa to continue cutting rates. “Yields should see a material drop”, he said, lifting bond prices.
García Zamora sees some potential risks coming from the US. They include interest rates moving higher and faster than expected, and a potential decline in oil prices, should another shale oil boom materialise.
He is also concerned about presidential elections South Africa, Brazil, Malaysia and Thailand in 2018. “Elections in economies where the institutions are of lower quality can completely change the direction of travel and that is a risk”.
Sunny days for bonds?
While some are predicting a global bond market crash, García Zamora has an optimistic view. “In the next two years there will be a much more constructive environment for this asset class.”
He bases his optimism on global interest rates and the direction of the US dollar.
“The US is 70% done in terms of normalising rates, but the European Central Bank has not even started yet,” he said. “When they start, the euro will go up against the dollar”.
The euro has already gained in value against the US dollar since the beginning of the year. It hovers now around $1.18, up from the low of $1.04 in December 2016.
The US government policy may support this trend. “[US president Donald] Trump came to power with a very different exchange rate policy compared to the prior US administration,” said García Zamora. “He wants a cheaper dollar because he wants to reduce the deficit with the main trading partners and he wants to bring jobs back to America.”
He added that stabilising commodity prices, which are expected to continue, also support a positive investment environment for fixed income.
Three-year performance of the BNY Mellon Emerging Markets Debt Local Currency Fund, vs its benchmark and category average
