BlueBay spotlights emerging markets opportunities following US yield spike

Emerging Markets

The widening valuation gap between emerging markets fixed income and its developed markets counterpart is set to throw up “interesting opportunities” for EM-focused investors and hedge funds once the recent US treasury yield spike stabilises, according to BlueBay Asset Management.

As US 10-year treasury yields spiralled this week – topping 1.6 per cent at one point – volatility across equity markets kept a lid on returns, while emerging markets fixed income, local markets, and sovereign and corporate credit were also all down.

The move in higher real rates has proved a headwind for EM fixed income – but has led to some eye-catching divergences in performance, said Anthony Kettle, senior portfolio manager, emerging markets at BlueBay in London.

EM fixed income returns were squeezed this week, with local currency markets underperforming, selling off by some 1.8 per cent, while corporate credits dipped 29 basis points, and sovereigns fell 82 bps. In one-month moves, local markets have fallen some 5 per cent, while sovereign markets are down 3.5 per cent – but corporate markets have slipped just 70 basis points.

“The performance of corporates is much closer to the performance of developed market credit, despite still being a laggard in this context,” Kettle said in a note on Thursday. “This leaves EM sovereign hard currency credit a clear underperformer in the credit space this year.”

Meanwhile, local markets’ performance this year has been “almost the opposite” of the consensus view at the start of 2021.

“Given the widening valuation gap between EMs and DMs in the fixed income space, we expect to see some interesting opportunities in EMs once the spike in US Treasury yields begins to stabilise,” Kettle noted, adding current yield levels are unlikely to be an obstacle to a sustained recovery.

The London-based fixed income and emerging markets-focused hedge fund firm observed how the recent US yield spike has created a rotation trade momentum within equities. Tech stocks have been dumped in favour of value names, triggering a rise in equity volatility, while commodities have duly rallied as investors sought classic reflation trades amid OPEC+’s surprise move to maintain production cuts.