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Will Economic Policy in Turkey Affect Emerging Market Bonds?

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KATHY JONES: Recently there’s been a steep selloff in emerging market bonds triggered by economic policy and political concerns in Turkey, and those concerns have spread to other emerging markets as well. I’m Kathy Jones and this is Bond Market Today.

Late last year, we suggested that investors consider underweighting emerging market bonds in their portfolios, and the reason was that we were concerned about a couple of things. First, that there had been a big jump in issuance of bonds denominated in foreign currencies among emerging market issuers—and usually that was in U.S. dollars or in euros. And as the Federal Reserve moved to tighten policy, along with the European Central Bank, we thought that there would be a risk that those currencies would move up relative to the emerging market currencies and make it harder for those issuers to pay back the debt. And we’re starting to see that now that the Fed has raised rates several times more, and the European Central Bank is moving to tighten policy. We’re starting to see those currencies move up, and that has contributed to this selloff in emerging market bonds.

We were also concerned at the time about valuations. In our view, valuations were really stretched at the time, yields were at all-time lows—both in absolute terms and relative to U.S. treasuries—and we didn’t think that investors were getting enough compensation to warrant the risk in those markets.

Now that prices have fallen steeply, we’re still reluctant to change our suggestion. We continue to think that this could play out over time, and that investors probably are best off maintaining that underweight to emerging market bonds until we get some signals that the situation is stabilizing.

If you’d like to learn more about bonds and fixed income in general, you can find us on Schwab.com on the Insights & Ideas tab. Go to the drop-down menu for Bond Insights, or follow me on Twitter @KathyJones. Thanks for watching.

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