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ETF Specialist

Emerging-Markets Bonds in a Rising U.S. Dollar Environment

Look to funds that focus on U.S. dollar-denominated debt.

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The U.S. dollar has been rising and likely will remain strong in the medium term, thanks to a relatively healthier U.S. economy and the expectation that the U.S. will normalize its monetary policy before the eurozone and Japan. In a strong U.S. dollar environment, investors considering emerging-markets bonds to diversify their portfolios may want to focus on funds that invest in U.S. dollar-denominated sovereign debt, such as  iShares J.P. Morgan USD Emerging Markets Bond (EMB) or  PowerShares Emerging Markets Sovereign Debt ETF (PCY), both of which are currently yielding above 4%. While a strong U.S. dollar makes it more expensive for emerging-markets sovereigns to repay their dollar-denominated debt, we note that for the most part, emerging-markets countries have ample foreign reserves. In addition, most emerging-markets countries' U.S. dollar debt is nowhere near levels seen in the mid-1990s--at that time, high levels of U.S. dollar-denominated debt helped contribute to the Asian financial crisis.

U.S. dollar-denominated emerging-markets bonds have historically exhibited low correlations to U.S. bonds. This is due to the fact that emerging-markets sovereign bonds carry credit risk, whereas U.S. Treasuries are "risk-free." During the past five years, the correlation between the emerging-markets bond benchmark, the J.P. Morgan Emerging Market Bond Index (J.P. Morgan EMBI), and the Barclays U.S. Aggregate Bond Index has been 0.47.

Patricia Oey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.