Getting real on rates

Inflation has been among the most popular terms across news headlines, research reports and economic forecasts. Whilst the loudest voices tend to dominate in the conversation, inflation is far from a certainty but global asset manager Eaton Vance suggest ‘it’s not an unlikely scenario’ and must be considered. Emerging markets bonds have been increasing in […]

Inflation has been among the most popular terms across news headlines, research reports and economic forecasts. Whilst the loudest voices tend to dominate in the conversation, inflation is far from a certainty but global asset manager Eaton Vance suggest ‘it’s not an unlikely scenario’ and must be considered.

Emerging markets bonds have been increasing in popularity in recent years, seeing significant flows from investors seeking to diversify their portfolio and access the higher income on offer. According to Eaton Vance, one of the most important macro indicators of value in emerging market bonds is the real interest differential both on a domestic basis and in comparison, to developed markets.

‘EM debt was hit hard in Q1 following the sudden, share and volatile rise in US treasury rate’ they suggest, which sent the JP Morgan GBI-EM Global Diversified Index down 6.68% in the quarter alone. Two third of the losses were due to the rise in Treasury rates with the result being capital flooding back home to the US.

Ultimately, the shift in narrative saw real rates, being the difference between the headline rate and inflation, in emerging market debt increase by 1.07%. On the other hand, real rates on developed market bonds remained flat at negative 0.5%, suggesting little to no after inflation return.  This sent the real interest rate differential to 1.67%, the widest in over 12 months according to the Emerging Markets team.

They remain proponents of an emerging market allocation suggesting that the key to ‘capitalising on the opportunities will rely heavily on understanding the economic trends’ which differ across every country. They highlight the fact that ‘many EM countries have had more recent experience with elevated inflation levels’ and are therefore likely to be better prepared for what lies ahead.

History points to a potential period of strong performance of EM debt, should inflation expectations continue to grow. Research shows that over the last 15 years there have been six cycles of rising and falling inflation expectations, and that in each of the former EM debt has delivered an average return of 13.8%.