Wednesday, July 25, 2012

Search for yield and emerging market bonds

With lower inflation rates, emerging market bonds are offering a great bond bull market opportunity. The higher yields also offer a place for generating current income. However, this based on the idea that emerging markets all have higher growth and controlled inflation. That may be harder to guarantee in the next few years.

The correlation between emerging market stocks, bonds and currencies has been broken because the credit differential between many emerging markets countries and developed countries has declined. There is not the same flight to quality between developed and merging markets. There is now flight to quality intra-emerging markets. Still these markets may again become correlated if there is a global downturn.

The demand for emerging market debt has been matched by growth in EM bonds. These fixed income makers are becoming deeper and more liquid. EM fixed income debt has moved from $2 trillion to over  $11.5 trillion since the beginning of the century. The search for yield has created willing buyers. Only the search for yield usually ends poorly.

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