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Emerging Market Bonds Bounce: More Upside Likely

Published 11/29/2022, 05:36 AM
Updated 07/09/2023, 06:31 AM
  • Weaker domestic inflation and lower dollar tailwinds for international fixed income
  • Emerging market bonds have rallied sharply off their October low
  • Continuation likely, but gains could be capped 
  • The bond market might be fixing itself. Last week, the iShares iBoxx High Yield corporate bond fund (NYSE:HYG) recorded another strong net inflow. The junk-bond ETF now paces for its second-biggest monthly net inflow since the fund’s inception. This comes as interest rates have cooled and breakeven inflation expectations have leveled off. 

    Risk On: Domestic High-Yield Bonds Enjoy Big November Inflows

    HYG Monthly Flows

    Source: Bloomberg

    Over the past month, U.S. Treasuries are up about 2% while corporate credit also features significant buying interest. The iShares iBoxx $ Inv Grade Corporate Bond ETF (NYSE:LQD) sports a total return of 6.5% while riskier high-yield debt, as measured by HYG is positive by 2%. The duration of LQD is much higher compared to HYG, so the recent drop in intermediate-term interest rates has been particularly beneficial for high-grade corporates. What is very green on the one-month ETF performance heat map below is price action in emerging market bonds. 

    One-Month Performance Heat Map: EMB Shines Among Fixed Income

    ETF Monthly Performance Heat Map

    Source: Finviz

    The iShares J.P. Morgan USD Emerging Markets Bond ETF (NASDAQ:EMB) is higher by 7%, including dividends. A weakening US Dollar Index provides an extra tailwind for foreign fixed income—especially EM debt. Callum Thomas at Topdown Charts always brings strong analysis combining technicals and the macro. He found that there is a bearish divergence between a recent new high in yields and the number of EM nations that are making new highs in yields—it is a telltale sign that the uptrend in emerging market rates could be in real jeopardy. (Which would be bullish EM bond prices.) 

    Bearish Yield Divergence: Bullish for EMB Prices

    10-Year Average Yield Vs. Composite Breadth Indicator

    Source: Topdown Charts

    Let’s dig into where EMB might go from here given this potentially bullish omen seen in the macro data. I zoomed out to the past 10 years using weekly candles on EMB. You can see how steep the drop from the peak more than a year ago has been. EMB plunged by nearly a third, shooting right through the COVID low. After a more than 10% advance off the October nadir, the fund is still $6 shy of its 50-week moving average. 

    I assert the ETF has further upside but might find some resistance just above $90—the August 2022 rebound high and where the falling 50-week moving average will come into play. The $91 level has more resistance confluence as the 38.2% Fibonacci retracement is seen there. 

    Notice, too, that there was a modest bullish divergence on the weekly RSI between the low in price this past July and the all-time low notched in mid-October. The RSI figure did not confirm a new low last month. So, there are some indications that the current bounce might have some legs. 

    EMB: Bullish Divergence, More Space to the Upside

    EMB ETF Daily

    Source: Stockcharts.com

    The Bottom Line

    As yields retreat amid easing inflation fears and a lower US dollar, emerging market debt has been a big beneficiary. I see more upside ahead, but gains could be capped by three key spots of resistance in the low $90s.

    Disclaimer: Mike Zaccardi does not own any of the securities mentioned in this article. 

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