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Fed Waiting Game: An EM Debt Perspective

May 15, 2024

Read Time 10+ MIN

As we wait on the Fed and watch the US fiscal deficit rise, emerging markets are showing why they deserve a deeper look from investors.
Average Annual Total Returns* (%) as of April 30, 2024
  1 MO 3 MO YTD 1 YR 3 YR 5 YR 10 YR
Class A: NAV (Inception 07/09/12) -1.43 -0.69 -1.71 4.64 -1.15 2.56 0.99
Class A: Maximum 0.0575% load -7.09 -6.40 -7.37 -1.37 -3.09 1.36 0.39
Class I: NAV (Inception 07/09/12) -1.48 -0.67 -1.51 4.87 -0.82 2.88 1.30
Class Y: NAV (Inception 07/09/12) -1.51 -0.54 -1.56 4.72 -0.91 2.81 1.24
50% GBI-EM/50% EMBI -2.10 -0.90 -2.16 5.09 -2.87 0.04 1.09

Average Annual Total Returns* (%) as of March 31, 2024
  1 MO 3 MO YTD 1 YR 3 YR 5 YR 10 YR
Class A: NAV (Inception 07/09/12) 0.68 -0.29 -0.29 6.76 0.35 2.90 1.39
Class A: Maximum 5.75% load -5.11 -6.02 -6.02 0.62 -1.62 1.69 0.79
Class I: NAV (Inception 07/09/12) 0.76 -0.03 -0.03 7.28 0.69 3.26 1.71
Class Y: NAV (Inception 07/09/12) 0.73 -0.05 -0.05 7.14 0.57 3.19 1.64
50% GBI-EM/50% EMBI 1.03 -0.05 -0.05 8.10 -1.45 0.48 1.42

* Returns less than one year are not annualized.

Expenses: Class A: Gross 2.55%, Net 1.22%; Class I: Gross 2.51%, Net 0.87%; Class Y: Gross 2.91%, Net 0.97%. Expenses are capped contractually until 05/01/24 at 1.25% for Class A, 0.95% for Class I, 1.00% for Class Y. Caps excluding acquired fund fees and expenses, interest, trading, dividends, and interest payments of securities sold short, taxes, and extraordinary expenses.

The performance data quoted represents past performance. Past performance is not a guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Performance may be lower or higher than performance data quoted. Please call 800.826.2333 or visit vaneck.com for performance current to the most recent month ended.

The “Net Asset Value” (NAV) of a Fund is determined at the close of each business day, and represents the dollar value of one share of the fund; it is calculated by taking the total assets of the fund, subtracting total liabilities, and dividing by the total number of shares outstanding. The NAV is not necessarily the same as the ETF’s intraday trading value. Investors should not expect to buy or sell shares at NAV.

Are we there yet? More specifically, now that everyone is bearish on Treasuries (and the Fed), is it time to be bullish?

Since everyone is bearish now, let’s start with the bullish side. On the bullish side for rates is the simple fact that four 25 bp rate cuts were priced out of 2024 during the quarter, and recession risks are arguably rising! If this is a pendulum (which it could be), it can swing back. Moreover, there are signs of internal economic weakness in the US, though those redound to forecasting (data such as car loan delinquencies, home affordability, etc.), rather than ex-post evidence. Our EM eyes would also tell us that pronounced political uncertainty always hurts growth, why would the US be any different? To strengthen the argument beyond rising recession risk, which is the main implication of the previous sentence, the Fed’s reaction function doesn’t present any obvious obstacles to allowing rate cut expectations to resume. Higher oil prices are a tax on the consumer to Fed thinking (and whether that is wrong or right, Fed policy is not viewed as being able to manage oil prices, other than in extremely destabilizing ways), so arguably pushes the Fed toward easing. The Fed has been claiming that even though its Financial Conditions Index (FCI) shows easing conditions, the Fed’s messaging has emphasized the simple real rate (which is a dovish framing). Similarly, when I speak with my rates colleagues in the market, I almost get laughed at when I wonder “why wouldn’t a strong disinflationary stance help the political-economic dynamic?” We ask the question because in most EM countries, harnessing a central bank to achieve economic outcomes beyond inflation is a non-starter for voters on the left (and on the right, obviously). Inflation kills the poor and can kill governments, so we would argue that this is a simple observation of global economic history. Anyway, we agree it’s ludicrous to imagine a Fed hiking with open political support, but not ludicrous to say they should (which is what Larry Summers is saying, without our flourishes). And if they should but don’t, well, here we are. There is not much more to say on this potential climax as our conclusion has always been the same – caution on duration. The fund is still strongly biased to be capped at neutral duration at most (though there are always some long-duration assets worth having at moments, which sometimes boils down to a diversification strategy – we can’t be too certain of our view on limited duration, too).

The verdict at IMF meetings, again - EM the winner, DM the problem, all due to “fiscal dominance”.

We clearly won’t let this topic go, and why should we? We discuss it in great detail in our white paper, and recently our teammates Dave Austerweil and Natalia Gurushina’s wrote about it in a full piece on the IMF meetings. The IMF doubled down on the theme at recent meetings. At the annual meeting in October 2023, the IMF made it the focus of the meetings, and that continued at the April meeting! We are not alone; this is a major sleeper issue that too many just ignore. More specifically, there were a couple of interesting framings that emanated around recent IMF meetings. Exhibit 1 shows that the US primary fiscal deficit is extremely sensitive to inflation surprises, whereas EMs primary balances are insensitive to inflation surprises. This is obviously due to high US debt compared to low EM debt, so it epitomizes the fiscal or debt constraint. In other words, if you think US fiscal issues will get solved, you better also expect high inflation.

Exhibit 2 below shows that US inflation is among the countries with higher inflation globally, but it’s recent rise is stark. This is completely consistent with R-star data we used in our “fiscal dominance” white paper, showing EMs’ R-star is declining, and DM’s R-star is arguably rising. If so, that’s deep, though slow. Only a crisis will change this, in our opinion. A final note:  all this analysis essentially lays out tracks and barriers for the fund, we are not thinking about fiscal dominance every day and trading EM based on that view. We are using our EM-focused investment process to do its job, while making sure that the portfolio doesn’t bump into any of the implications of these seemingly nebulous facts. Low duration, high spread, idiosyncrasy, benefiting from higher commodity prices, etc. It just happens that EMs have many winners and DMs have many losers, so we’re in an attractive alpha territory in EM bonds.

Exhibit 1 – US Primary Deficit Depends on Inflation, EM Primary Deficit Does Not

Exhibit 1 - US Primary Deficit Depends on Inflation, EM Primary Deficit Does Not

Source: International Monetary Fund, Data as of April 2024.

Exhibit 2 – Inflation Is High and Moving Higher in the US, Not EM

Exhibit 2 - Inflation Is High and Moving Higher in the US, Not EM

Source: Deutsche Bank, Refinitiv, Haver Analytics.

It sure looks like a name with extreme bearish positioning combined with good fundamental news, and we all know what Paul Tudor Jones said when the technical and the fundamental line up. Policy is firming, with the government signaling that it will support project completions on swaths of ongoing building. And there’s the Purchasing Managers Index (PMI) showing expansion. US officials essentially confirmed all of this by expressing concern of “overcapacity”, which to other eyes is simple productivity and competitive advantage. In fact, that’s a teachable moment, as since at least 2008 the US and DM abandoned many orthodox playbooks because, well, it would be painful. Fair, but not an attractive investment context for the DM, as investors must pay for this political risk. Ultimately, China looks set to face higher US and European tariffs, and sanctions from the US are basically on long-term autopilot to “more”, so we remain nimble and cautious. But, for us in China, that continues to mean small, diversified exposures to beaten-up names. China has been a “little engine that could”, with small exposure doing a lot of work. But we can’t marry the trade.

The changes to our top positions are summarized below. Our largest positions in April were Mexico, Brazil, Indonesia, Chile, and South Africa:

  • We increased our local currency exposure in Mexico, South Africa, Turkey, and Brazil. Mexico’s central bank sounds very cautious on the pace of policy easing while domestic activity is firming. South Africa’s growth gauges also look more encouraging, and the economy can further benefit from China’s recovery. A lot of political risks are already priced in, and the latest polls point to a more manageable and less radical governing coalition. Brazil’s valuations look attractive, and the currency was lagging the peers, affected in part by concerns about Petrobras dividends, which had subsequently been resolved. Finally, Turkey’s policy U-turn is firmly in place after the local elections, the central bank remains hawkish and vigilant, and there are now good prospects for capital inflows and fewer reasons for capital flight.
  • We also increased our hard currency corporate exposure in China, Singapore, and Argentina, as well as hard currency sovereign exposure in Argentina. We are seeing more signs of economic adjustment in Argentina, including fiscal performance, the current account balance improvement, and higher international reserves. There are further attempts to keep the policy U-turn going, and the key reform bill is now in the parliament. China’s economy continues to recover, and authorities signal more policy support with an emphasis on real estate, which can be a much-needed catalyst both for the sector and domestic consumption. Singapore’s bond was a new and attractively priced issue. 
  • Finally, we increased our hard currency sovereign exposure in Nigeria, El Salvador, Bolivia, and Bahamas. In Nigeria, we are seeing more positive signals on the policy front, especially the exchange rate unification and tight monetary stance. El Salvador issued a new bond which eased their payment schedule. The Bahamas government is deleveraging aggressively, and the IMF meetings suggest that there can be less deviation from the 2024 fiscal target. In Bolivia, the senate authorized USD325 million in external financing and a major sugar mill announced a sizable investment project to boost its ethanol capacity.
  • We reduced our local currency exposure in Poland, Colombia, and Malaysia. Poland’s central bank and the government might be too busy playing political games, while inflation might accelerate a lot if price caps are removed. The country’s valuations also do not look attractive. Colombia’s fiscal concerns refuse to die down, and the Minister of Finance just added more fuel to the fire by saying that he wants to make the already stretched fiscal rule more “flexible”. A major disadvantage in Malaysia is that its low-carry currency is highly correlated with the Chinese renminbi.
  • We also reduced our hard currency sovereign exposure in Saudi Arabia, United Arab Emirates, and Qatar. Saudi Arabia might be moving from twin surpluses to twin deficits, and this is not reflected in valuations. A lack of a clear medium-term fiscal strategy also generates confusion against the backdrop of seemingly “never-ending” issuance as new debt is more expensive and the maturity profile gets heavier. Duration concerns were a major consideration in Qatar, especially if the U.S. Federal Reserve has less room to cut. The United Arab Emirates’ status as a proxy for global duration was the reason we decided to use the position as a funder for more interesting opportunities.
  • Finally, we reduced our hard currency sovereign exposure in Romania. Romania’s pre-election fiscal spending and political noise create a worrisome backdrop, with additional concerns coming from a citizenship bill which might potentially require military intervention in neighboring Moldova if the Russia-Ukraine conflict escalates and spreads further.

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Disclosures

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.

Duration measures a bond’s sensitivity to interest rate changes that reflects the change in a bond’s price given a change in yield. This duration measure is appropriate for bonds with embedded options. Carry is the benefit or cost for owning an asset. Yield to worst is a measure of the lowest possible yield that can be received on a bond with an early retirement provision. Averages are market weighted. The yields presented do not represent the performance of the Fund. These statistics do not take into account fees and expenses associated with investments of the Fund.

All indices are unmanaged and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. Certain indices may take into account withholding taxes. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

The Fund’s benchmark index (50% GBI-EM/50% EMBI) is a blended index consisting of 50% J.P. Morgan Government Bond Index-Emerging Markets (GBI-EM) Global Diversified and 50% J.P. Morgan Emerging Markets Bond Index (EMBI). The J.P. Morgan GBI-EM Global Diversified tracks local currency bonds issued by Emerging Markets governments. The J.P. Morgan EMBI Global Diversified tracks returns for actively traded external debt instruments in emerging markets, and is also J.P. Morgan’s most liquid U.S dollar emerging markets debt benchmark.

Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The Index is used with permission. The index may not be copied, used or distributed without J.P. Morgan’s written approval. Copyright 2023, J.P. Morgan Chase & Co. All rights reserved.

J.P. Morgan GBI-EM Global Diversified Index tracks local currency denominated EM government debt. The index weighting methodology limits the weight of countries with larger debt stocks, with a maximum of 10%.

J.P. Morgan EMBI Global Diversified Index is comprised of U.S. dollar-denominated Brady bonds, Eurobonds, and traded loans issued by emerging markets sovereign and quasi-sovereign entities. The index weighting methodology limits the weight of countries with larger debt stocks.

ICE BofA U.S. Treasury Index racks the performance of EUR denominated sovereign debt publicly issued by the German government in the German domestic or eurobond market.

ICE BofA German Government Index tracks the performance of EUR denominated sovereign debt publicly issued by the German government in the German domestic or eurobond market.

ICE BofA Global Broad Market Index tracks the performance of investment grade debt publicly issued in the major domestic and eurobond markets, including sovereign, quasi-government, corporate, securitized and collateralized securities.

ICE BofA Japan Government Index tracks the performance of JPY denominated sovereign debt publicly issued by the Japanese government in its domestic market.

ICE BofA UK Gilt Index tracks the performance of JPY denominated sovereign debt publicly issued by the Japanese government in its domestic market.

You can lose money by investing in the Fund. Any investment in the Fund should be part of an overall investment program, not a complete program. The Fund is subject to risks which may include, but are not limited to, risks associated with active management, credit, credit-linked notes, currency management strategies, derivatives, emerging market issuers, energy sector, ESG investing strategy, foreign currency, foreign securities, hedging, high portfolio turnover, high yield securities, interest rate, LIBOR replacement, market, non-diversified, operational, restricted securities, investing in other funds, sovereign bond, and special risk considerations of investing in Latin American issuers, all of which may adversely affect the Fund. Emerging market issuers and foreign securities may be subject to securities markets, political and economic, investment and repatriation restrictions, different rules and regulations, less publicly available financial information, foreign currency and exchange rates, operational and settlement, and corporate and securities laws risks. Derivatives may involve certain costs and risks such as liquidity, interest rate, and the risk that a position could not be closed when most advantageous.

ESG integration is the practice of incorporating material environmental, social and governance (ESG) information or insights alongside traditional measures into the investment decision process to improve long term financial outcomes of portfolios. Unless otherwise stated within an active investment strategy’s investment objective, inclusion of this statement does not imply that an active investment strategy has an ESG-aligned investment objective, but rather describes how ESG information may be integrated into the overall investment process.

Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Securities Corporation.

© 2024 Van Eck Securities Corporation, Distributor, a wholly-owned subsidiary of Van Eck Associates Corporation.

Disclosures

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.

Duration measures a bond’s sensitivity to interest rate changes that reflects the change in a bond’s price given a change in yield. This duration measure is appropriate for bonds with embedded options. Carry is the benefit or cost for owning an asset. Yield to worst is a measure of the lowest possible yield that can be received on a bond with an early retirement provision. Averages are market weighted. The yields presented do not represent the performance of the Fund. These statistics do not take into account fees and expenses associated with investments of the Fund.

All indices are unmanaged and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. Certain indices may take into account withholding taxes. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

The Fund’s benchmark index (50% GBI-EM/50% EMBI) is a blended index consisting of 50% J.P. Morgan Government Bond Index-Emerging Markets (GBI-EM) Global Diversified and 50% J.P. Morgan Emerging Markets Bond Index (EMBI). The J.P. Morgan GBI-EM Global Diversified tracks local currency bonds issued by Emerging Markets governments. The J.P. Morgan EMBI Global Diversified tracks returns for actively traded external debt instruments in emerging markets, and is also J.P. Morgan’s most liquid U.S dollar emerging markets debt benchmark.

Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The Index is used with permission. The index may not be copied, used or distributed without J.P. Morgan’s written approval. Copyright 2023, J.P. Morgan Chase & Co. All rights reserved.

J.P. Morgan GBI-EM Global Diversified Index tracks local currency denominated EM government debt. The index weighting methodology limits the weight of countries with larger debt stocks, with a maximum of 10%.

J.P. Morgan EMBI Global Diversified Index is comprised of U.S. dollar-denominated Brady bonds, Eurobonds, and traded loans issued by emerging markets sovereign and quasi-sovereign entities. The index weighting methodology limits the weight of countries with larger debt stocks.

ICE BofA U.S. Treasury Index racks the performance of EUR denominated sovereign debt publicly issued by the German government in the German domestic or eurobond market.

ICE BofA German Government Index tracks the performance of EUR denominated sovereign debt publicly issued by the German government in the German domestic or eurobond market.

ICE BofA Global Broad Market Index tracks the performance of investment grade debt publicly issued in the major domestic and eurobond markets, including sovereign, quasi-government, corporate, securitized and collateralized securities.

ICE BofA Japan Government Index tracks the performance of JPY denominated sovereign debt publicly issued by the Japanese government in its domestic market.

ICE BofA UK Gilt Index tracks the performance of JPY denominated sovereign debt publicly issued by the Japanese government in its domestic market.

You can lose money by investing in the Fund. Any investment in the Fund should be part of an overall investment program, not a complete program. The Fund is subject to risks which may include, but are not limited to, risks associated with active management, credit, credit-linked notes, currency management strategies, derivatives, emerging market issuers, energy sector, ESG investing strategy, foreign currency, foreign securities, hedging, high portfolio turnover, high yield securities, interest rate, LIBOR replacement, market, non-diversified, operational, restricted securities, investing in other funds, sovereign bond, and special risk considerations of investing in Latin American issuers, all of which may adversely affect the Fund. Emerging market issuers and foreign securities may be subject to securities markets, political and economic, investment and repatriation restrictions, different rules and regulations, less publicly available financial information, foreign currency and exchange rates, operational and settlement, and corporate and securities laws risks. Derivatives may involve certain costs and risks such as liquidity, interest rate, and the risk that a position could not be closed when most advantageous.

ESG integration is the practice of incorporating material environmental, social and governance (ESG) information or insights alongside traditional measures into the investment decision process to improve long term financial outcomes of portfolios. Unless otherwise stated within an active investment strategy’s investment objective, inclusion of this statement does not imply that an active investment strategy has an ESG-aligned investment objective, but rather describes how ESG information may be integrated into the overall investment process.

Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Securities Corporation.

© 2024 Van Eck Securities Corporation, Distributor, a wholly-owned subsidiary of Van Eck Associates Corporation.