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Bonds issued by some of the world’s poorest countries have been the best performers in sovereign debt markets this year, shrugging off the impact of high US borrowing costs, which often spook investors in riskier economies.
Emerging market sovereign bonds denominated in foreign currencies — mainly the dollar — and holding a triple B “junk” rating or lower have delivered a 4.9 per cent total return for investors this year. That compares with a loss of 3.3 per cent for an index of US Treasury bonds.
The gains have come as the resilience of the global economy surprised investors, while higher commodity prices have benefited countries such as oil exporters Nigeria and Angola and copper producer Zambia. Meanwhile, support from lenders such as the IMF has helped those in debt distress or default such as Sri Lanka and Zambia.
“Emerging markets have done much better than anyone would have expected,” said David Hauner, head of global emerging markets fixed income strategy at Bank of America.
“Clearly the credit component of EM sovereign bonds has held up well because the fundamentals have been improving,” he added, referring to the premium investors demand to hold riskier debt rather than US Treasuries.
Higher bond yields in the US and Europe usually spell trouble for developing countries because capital is lured back to the improved returns on offer in home markets, and because the cost of refinancing dollar or euro-denominated debt increases.
This year investors have pulled close to $12bn from emerging market debt funds as they chase returns elsewhere, for instance in US high-yield debt funds, which have had net inflows of $2bn, according to JPMorgan analysts.
However, some investors believe these outflows are set to reverse, particularly if the outlook for US corporates worsens.
“As capital flows back into EM this should be supportive for the asset class. In contrast, the tide that has lifted the US high-yield market is on the wane,” said Grant Webster, co-head of emerging market and sovereign FX at asset manager Ninety One.
Resilience across emerging economies has come alongside progress on domestic reforms and restructuring talks in a number of countries.
Argentina’s bonds have been among the top performers, gaining 39 per cent year to date, as investors have welcomed a radical austerity package and deregulation by President Javier Milei.
Meanwhile, dollar bonds in Sri Lanka, Ghana and Zambia have all delivered double-digit returns this year as they enter the final phase of the restructuring process.
“The most fragile countries in EM are becoming less fragile,” said Paul Greer, an emerging markets debt portfolio manager at Fidelity International. “A lot of that is because of . . . domestic policy reforms and changes.”
Significant support from the IMF and other official creditors in recent months has also helped, by reducing the likelihood of more sovereign debt defaults this year, say investors.
The lender has increased the size of its bailout loan for Egypt to $8bn, while the United Arab Emirates has invested $35bn to help the country weather the fallout from the war in Gaza. Last month the fund approved the release of the final $1.1bn tranche of a $3bn bailout to Pakistan.
“Egypt, Pakistan and Kenya were the big three maturities in 2024 but they are no longer viewed as high risk of default,” said Kevin Daly, investment director at Abrdn.
Fidelity’s Greer said access for some frontier economy debt has also improved, with the Ivory Coast, Kenya, Benin and El Salvador all tapping international markets this year, which was “kind of unthinkable four months ago”.
The strong performance of some high yield emerging market countries has helped lift JPMorgan’s broader foreign currency EM sovereign bond index 1.4 per cent. That compares with a 3 per cent fall for an index of high-grade global bonds.
The robust performance comes despite forecasts from the IMF that economic growth across emerging markets will be slightly lower this year than last. Speaking to CNBC last week, the fund’s managing director said higher interest rates in the US could be an acute problem for emerging economies.
Local currency EM bonds have suffered more than their dollar-denominated peers. The strength of the US currency has weighed on returns for western investors and constrained other central banks’ ability to cut interest rates without risking a resurgence of inflation.
JPMorgan’s local currency emerging market index has fallen 2.2 per cent this year with the some of the biggest falls in Chile, Turkey and Thailand. Bonds in Indonesia have fallen 3 per cent since January following a surprise rate rise late last month to 6.25 per cent.
Still, BofA’s Hauner said the sell off had been relatively contained and that while returns look poor in dollar terms, “a lot of investors in Europe and Japan are still happy with their EM debt”.
