Emerging market bonds denominated in local currencies enjoyed a record January last month with JP Morgan’s GBI-EM Global index returning around 8 percent in dollar terms. Year-to-date, returns are over 9.5 percent.
This is mainly down to spectacular gains on emerging currencies such as the Mexican peso and Turkish lira which have surged 7-10 percent against the dollar and euro this year. Analysts say the currency component of this year’s returns has been around 7 percent, meaning any portfolio hedged for currency risk would have garnered returns of just 2.5 percent.
The gains come as good news to investors licking their wounds after the index ended 2011 in negative territory. A mid-year rout on emerging markets pushed up local bond yields, often by hundreds of basis points and sent many currencies to multi-year lows.
Now, promises of more cheap cash from Western central banks has changed the mood, driving currency rallies. Adding to the optimism is the hope of more interest rate cuts in emerging markets, where inflation has peaked and growth is slowing.
It is unlikely however that such gains on local currency debt can be sustained. Already many countries are moving to stem currency appreciation — Brazil for instance last week resumed purchases of dollar forwards to curb the real’s gains against the dollar.