Permanent Value

Week in Review 6/24/13

Bruce Doole
June 25th, 2013


What happened?

Starting May, bond markets began focusing on the possibility of higher U.S. interest rates. From May 2 through June 13, the U.S. Treasury 10-year bond yield increased 52 bps and rate volatility rose, impairing emerging market debt (EMD) assets. Several consecutive months of inflows into emerging markets became outflows in early June, which coincided with a sharp drop in market liquidity, exacerbating price moves. During this period, the U.S. dollar experienced strength, amplifying declines in local-currency emerging bonds.

What should emerging markets investors do?

In the short term, EMD performance will likely closely respond to any change of expectation for future Fed action. We do not think, however, that the US macro outlook—Fed policy, growth and inflation—points to an imminent and meaningful rise in interest rates in the near-term. Perhaps market participants were a little too gloomy about the prospects for US economic growth in late April and early May (when 10-year Treasury yields reached 1.62%) and a little too hasty in positioning for a Fed “tapering” in late May and early June. Shifting market expectations about Fed policy may cause further interest rate gyrations, but we continue to anticipate 10-year Treasury yields, on average, between 1.75% and 2.25% over the next 3-6 months.

While recent EMD returns were negatively affected by a triple whammy of rising treasury yields, wider spreads, and weaker currencies, the combination of still-strong fundamentals and (now) more attractive valuations should bring investors back to the market, putting downward pressure on spreads/yields. Most emerging market countries continue to offer faster growth, lower debt-to-GDP levels and fiscal deficits, and larger currency reserves, while developed market countries are still facing a number of macroeconomic headwinds despite years of unprecedented monetary stimulus.


Source: Payden & Rygel Investment Management