Global bond investors seeking yield are still currently better served by U.S. high yield corporate bonds on average than EM sovereigns.
E merging market U.S. dollar-denominated sovereign (EM) debt is a viable alternative to satisfy investors’ search for yield in the ongoing low interest rate environment.
EM bonds are an out-of-benchmark credit play that on average offer more than 300 bps of yield pick-up relative to U.S. Treasurys and about a 150 bps advantage over U.S. investment grade credit. Although pockets of value in EM markets exist, our Global Fixed Income Strategy service prefers the risk-reward profile of the U.S. high yield sector for developed market global bond investors.
In the long term, benefits from holding EM debt within a global developed market bond portfolio include diversification and potential spread compression due to improving credit quality. However, in the current environment, most EM sovereign debt does not offer enough advantages over comparable quality U.S. corporate credit to merit a significant position.
Since the beginning of this year, market optimism and the “risk-on” trade have pushed credit spreads tighter in general. We expect this trend to continue at a much slower pace going forward. EM bonds have outperformed U.S. high yield bonds since the beginning of the year, but the former are particularly vulnerable to event risks and to a shift in sentiment.
That said, for investors that are seeking yield in EM sovereign markets, countries that benefit from higher oil prices offer the best relative prospects and are a potential hedge in the event of a supply-driven oil price shock.