Written by: Fran Rodilosso , CFA, Head of Fixed Income ETF Portfolio Management
Real yields in emerging markets (EM) have remained at compelling levels over the past few years even as they continued to decline in developed markets, and even as nominal yield levels declined in some EM countries. All else equal, currencies associated with higher real yields are generally expected to perform better than those with relatively lower real yields. And as the chart below shows, the real yield pictured in emerging markets is as attractive as it has been in five years.
Last summer we examined why real yields matter to emerging markets bond investors . Given the persistence of the real yield advantage, we believe it is worth revisiting why investors should focus on real yields.
Real yields are nominal yields adjusted for inflation, which is often one of the greatest contributors to the nominal yield levels of emerging markets local currency bonds. These higher nominal yields provide compensation for the risk posed by local inflation, which can be associated with negative currency returns. Controlled inflation can provide support to local currencies, and when combined with relatively high nominal yields (therefore resulting in positive real yields), fixed income assets may be particularly attractive.
From a policy perspective, positive real yields provide central banks the ability to ease monetary policy to spur growth, a policy tool that is not currently available in most developed markets. Overall, positive real yields can therefore be a better indication of fundamental value versus nominal yields.
Relative to developed markets, emerging markets local rates appear attractive in both nominal and real terms, despite rising real yields in the United States. As of March 31, 2018 the weighted average 10-year yield on the J.P. Morgan GBI-EM Global Diversified Index was 6.26%, versus the 10-year U.S. Treasury yield of 2.74%. In real terms, EM were yielding 2.85% above inflation, which was 2.26% more than U.S. Treasuries and 3.60% more than the G-4 (U.S., United Kingdom, Japan and Eurozone) average, which actually remains well into negative territory.IMPORTANT DISCLOSURE