Emerging markets local currency debt: Capitalising on improved sovereign fundamentals


Emerging markets local currency-denominated debt is a relatively large and liquid asset class that represents some of the most creditworthy emerging market sovereigns, offers two distinct sources of return (currency and local bond yields), and provides the potential to generate equity-like returns without taking on direct equity risk. We expect the sizeable growth differentials between emerging market countries and the developed world to continue serving as a magnet for capital flows into emerging markets. These capital inflows should augment appreciation pressures on many emerging market currencies, especially in the context of a global economic recovery. Reflecting the persistently positive term premium of local yield curves, emerging market government bonds have provided a better way to get emerging market currency exposure than currency forwards. Bond managers, however, may selectively use currency forwards in those situations where the currency is attractive but not prospective duration returns.

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