We continue to favour EM sovereign debt as an alternative to stretched developed-market debt. We like the higher initial yields on offer and potential capital upside from monetary easing and rolldown from steeper yield curves (top-left chart).

If we looked only at historical statistics, US Treasuries score more favourably in terms of diversification value to US equities, ie UST returns are negatively correlated to US equities while EM sovereign debt (both local currency and USD-denominated) is not as an effective hedge (top-right chart). But looking forward, while our US recession indicator remains muted, the egregious overbuying of US Treasuries will serve to erode their value as a diversifier in multi-asset portfolios. In contrast EM bond ETF flows have been weak in recent months and are just starting to turn up again (bottom-left chart). This has allowed EM yields to remain elevated even as the duration of EM USD debt has fallen below that of the Bloomberg Barclays US Treasury Index (last chart). Within the EM bond space, we advocate being selective and looking at local-currency debt that will benefit the most from stimulative monetary policies while upside inflation risks are contained, eg India, Mexico and Indonesia.

(Click on image to enlarge)

Source: Bloomberg, Macrobond, Variant Perception