EM Debt Turns Negative for Year as Treasury Selloff Bites

Emerging market dollar bonds are under pressure as increasing U.S. Treasury yields and tight credit spreads lead investors to scale back riskier positions. Despite a 1.4% return over the past year, fund managers from Aegon USA Investment Management to JPMorgan Asset Management are becoming more defensive. Spreads on developing-world dollar debt have narrowed to 170 basis points over Treasuries, the tightest level since 2007, leaving less cushion if Treasury yields continue to climb.

Fund managers are adjusting their strategies by moving into higher-quality issuers and local-currency debt. For example, Aegon's Jeff Grills has trimmed exposure to Colombia and added debt from Indonesia, Saudi Arabia, and the Philippines. Neuberger Berman's Gorky Urquieta has cut high-yield positions in Ecuador, the Dominican Republic, and Zambia, opting for a "retrenchment mode." PPM America is also upgrading its quality by adding duration through Morocco and reducing riskier assets like Angola.

Schroders sees value in investment-grade names affected by the broader sell-off, with Fernando Grisales adding Saudi Aramco notes and Mexico's dollar debt. JPMorgan Asset Management is reducing sensitivity to credit sell-offs and reallocating risk to local-currency bonds in countries like Mexico, Brazil, and Colombia, which are supported by high domestic interest rates and elevated commodity prices. This shift reflects concerns over a more aggressive Federal Reserve policy due to sticky inflation and a resilient U.S. economy.

The Bloomberg EM Sovereign Total Return Index, tracking government debt from 72 developing nations, dropped 2.4% in June and underperformed Treasuries, heading for its biggest annual decline since 2022. Caution is also evident in fund flows, with the largest exchange-traded fund for emerging market hard-currency bonds experiencing some of its biggest single-day outflows since March. Despite these pressures, local-currency EM debt is up 0.9% this year, and a broad gauge of developing-world stocks has risen over 23%, outperforming developed-market equities.