Taking Advantage of Diverging Policies

While the experience in the global bond market over the past few years conditioned us to expect strong positive correlations in fixed income returns across markets, we believe we are now at an inflection point in the cycle where monetary policy (and bond market) divergences will occur. This is certainly true when comparing markets across the DM and EM blocks, but also true when looking within each block. Going forward, we expect divergences will become more pronounced across all DM and EM bond markets.

With these emerging opportunities in mind, Alexandra Gorewicz, VP & Director, Active Fixed Income Portfolio Management, Hafiz Noordin CFA, VP & Director, Active Fixed Income Portfolio Management, and Sam Chai, VP, Active Fixed Income Portfolio Management, TD Asset Management Inc. (TDAM) recently authored an article titled Emerging Opportunities in Diverging Policies. The article highlights the nuanced opportunities in global fixed income today.

More specifically, the article highlights three key investment opportunities that are emerging in fixed income. The first opportunity is around the importance of accounting for currency hedging costs when analyzing DM bond yields. The second opportunity addresses the monetary policy tightening trends in Japan, and the third section outlines the opportunities within EM bond markets.

While the article is stacked with great insights, of particular interest is the third section titled EM Bond Markets - the early bird gets the worm. Here, the authors outline how some EM central banks began raising policy rates 6 to 12 months before the U.S. Federal Reserve, the Bank of Canada and other DM markets. Today, with inflation retreating quickly, several EM central banks have not only been able to pause rate hikes for many months now, but some of them are expected to pivot toward easing this summer.

Against this backdrop, year to date, some local EM bond markets have already appreciated substantially as disinflation themes have become more credible. However, given the magnitude of real rates in some EM countries and regions, particularly Latin America and Asia, local currency investments in those EM currencies and government bonds still present attractive opportunities to earn incremental yields compared to DM governments and even DM corporate bonds.

The increasing divergences between central banks’ policy paths at this stage in the global monetary cycle will likely see bouts of volatility, particularly with respect to currency fluctuations. Therefore, tactical risk management of currency exposures is critical to protect capital deployed abroad as the central bank divergence theme gains traction. This is true as Canadian investors take advantage of investment opportunities in DM and EM countries, alike.

Remember to check out the full article located on our insights page.

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