The global credit selloff is putting a dent in what had been a strong stretch for emerging-market debt. Over the past year, dollar bonds from developing countries returned 1.4%, but that resilience now has investors uneasy. Treasury yields have climbed to levels not seen in almost 20 years and oil sits above $100, leaving less room for error.
The belt-tightening is not isolated. Neuberger Berman's Gorky Urquieta has scaled back high-yield names such as Ecuador, Dominican Republic and Zambia, and says putting more risk on is tough right now. "We've been a little bit more on a retrenchment mode," he said.
Rather than abandon EM altogether, several managers are trading up in quality. At PPM America, Matt Graves has extended duration with stronger borrowers like Morocco and trimmed positions that rallied earlier this year, including Angola.
Others are hunting for value where the Treasury selloff has hit hardest. In New York, Schroders' senior portfolio manager Fernando Grisales has been picking up Saudi Aramco notes and Mexico's dollar bonds. "There is value opening up in the long end of the curve in investment grade credits that are very robust," he said.
JPMorgan Asset Management is leaning more on local markets. "We are a little bit less at risk," he said. "We've been taking the other side a bit more through the local markets rather than credit."
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Despite surging Treasury yields and oil above $100, emerging-market dollar bonds have mostly held onto gains. That strength is exactly what has some managers nervous. JPMorgan data show developing-nation dollar spreads at 170 basis points over Treasuries, the tightest since 2007. With valuations already rich, there is not much buffer if global rates lurch higher again.
Bloomberg Intelligence flags Federal Reserve policy as the key threat to hard-currency EM debt in the fourth quarter and warns that spreads near a 19-year low could make country-specific shocks hit harder. A run of sticky inflation and a still-strong US economy has pushed traders to anticipate a steeper path for Fed tightening.
Caution is creeping into fund flows. The biggest ETF that tracks hard-currency emerging-market bonds just saw some of its largest single-day outflows since March. Even so, local-currency EM debt is up 0.9% on average this year, and a broad gauge of developing-world stocks has climbed more than 23%, topping developed-market equities. High domestic rates and firm commodity prices have kept markets such as Brazil and Colombia on investor shortlists.
The through-line here is simple: less cushion, more selectivity. With spreads near 2007 tights and global rates resetting higher, many managers are upgrading credit quality, nudging risk into local markets and being choosier on where to add duration. For anyone holding EM exposure, expect portfolios to emphasize sturdier names and local bonds until valuations rebuild a safety margin.
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