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Opinion

Rockier road ahead for local-currency markets

Local-currency debt markets in emerging economies are beginning to suffer from the credit crisis and broader global slowdown.

Emerging markets have outperformed global credit markets since the turmoil began in August. But the bet that the asset class will continue to be a safe haven seems shakier by the day.

The spread for the benchmark JPMorgan Emerging Markets Bond Index Plus has widened out to its highest level in several years, hovering around 300 basis points over US Treasuries. Admittedly, what is happening to the Embi+ is less important than it once was. External debt markets are shrinking and account for less than 20% of total debt outstanding in the emerging markets universe, according to the Bank for International Settlements.

Instead the fortunes of the asset class are more closely intertwined with the local-currency markets, which account for more than $5.8 trillion of outstanding marketable securities. For the past few years, the local-currency markets have provided a big source of alpha for emerging markets investors. During the past four years, local-currency bonds provided an annualized return of 17.04% in dollar terms, according to JPMorgan’s GBI-EM Global Diversified index. In the 12 months up to March 19, these assets yielded a return of 19.1% compared with 4.9% from the Embi+.

Tellingly, their performance has tailed off dramatically this year, yielding a return of only 3.4%

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