Why investors should consider emerging markets bonds in 2024 (2024)

FAQs

Why investors should consider emerging markets bonds in 2024? ›

Vanguard's active fixed income team believes emerging markets (EM) bonds could outperform much of the rest of the fixed income market in 2024 because of the likelihood of declining global interest rates, the current yield premium over U.S. investment-grade bonds, and a longer duration profile than U.S. high yield.

Positive Signals for Future Returns

At the beginning of 2024, bond yields, the rate of return they generate for investors, were near post-financial crisis highs¹—and for fixed-income, yields have historically served as a good proxy for future returns.

Emerging markets' growth is expected to remain steady in 2024 at around 4%. Recently released emerging economies' manufacturing and services Purchasing Managers Index surveys, which focus on current and near-term economic expectations, mostly point to economic expansion in the coming months.

Emerging markets had a strong start to 2024, posting positive total returns despite significant headwinds from the move higher in US interest rates. Emerging market countries and corporates with lower ratings performed particularly well with spread compression occurring across regions and market segments.

Consider EM bonds carefully

Among the opportunities in the fixed income markets in 2024, local-currency EM bonds may be one to consider for investors with a higher risk tolerance. The relatively high yields and likelihood of rate cuts by global central banks have created a tactical investment opportunity.

Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds. High-quality bond investments remain attractive.

The Big Money bulls forecast that the Dow Jones Industrial Average will end 2024 at about 41,231, 9% higher than current levels. Market optimists had a mean forecast of 5461 for the S&P 500 and 17,143 for the Nasdaq Composite —up 9% and 10%, respectively, from where the indexes were trading on May 1.

An emerging market has the potential for strong economic growth. It is more established than a frontier market, which is usually deemed too small or risky but less than a developed one. They can be attractive to investors due to their rapid growth prospects, but they can be volatile and, therefore, risky.

Economic Growth

In calendar year 2023, the U.S. economy grew faster than it did in 2022, even as inflation slowed. Economic growth is projected to slow in 2024 amid increased unemployment and lower inflation. CBO expects the Federal Reserve to respond by reducing interest rates, starting in the middle of the year.

What is the outlook for emerging markets bonds? ›

After solid performance in 2023, the prospects for emerging market bonds remain promising amid a favourable macroeconomic backdrop and continued easing of monetary policy, which would support the asset class, according to Claudia Calich, M&G's Head of Emerging Markets Debt.

Our 2024 real GDP growth forecast for EMs excluding China is 3.9%, (from 3.8% previously), broadly unchanged from 4.0% growth in 2023. Our 2025 growth projections are also broadly unchanged--we forecast EMs excluding China to grow 4.4% that year.

In short, a review of the three standard approaches to EM allocation suggest global equity investors should allocate somewhere in the range of 13% to 39% to EM. Source: FactSet, MSCI, MSIM calculations.

Expecting another strong year in 2024

Following large front-loaded new issue supply, EM IG spreads are now at attractive levels versus U.S. credit, setting up EM debt for outperformance. Our 2024 macroeconomic base case features slowing inflation and growth cushioned by Fed rate cuts.

There are indications that interest rates may start to fall in the near future, with widespread anticipation for multiple interest rate cuts in 2024. Falling rates offer the potential for capital appreciation and increased diversification benefits for bond investors.

Investors include bonds in their investment portfolios for a range of reasons including income generation, capital preservation, capital appreciation and as a hedge against economic slowdown.

We expect monetary policy to become increasingly restrictive in real terms in 2024 as inflation falls and offsetting forces wane. The economy will experience a mild downturn as a result. This is necessary to finish the job of returning inflation to target.

Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.

The reason is that an investor can have greater control over their cash flows, rather than being subject to reinvestment risk—that is, the risk of having to reinvest a maturing security at a lower interest rate in the future.

In 2024 we remain positive on the credit market, anticipating strong total returns and continued demand from yield and duration buyers. Investors are looking to add high-quality duration and to move away from short-maturity investment solutions, made less attractive by major central banks' expected interest rate cuts.