Latest / The Emerging Markets Podcast with Fexingo: Developing Economies, Growth, and Investment / How Emerging Market Bond Yields Signal a New Divide
Transcript
- Lucas: So, Luna, I've been staring at the numbers all week, and there's something that keeps bugging me. Emerging market equities have had a pretty solid week — EEM is up over two percent in five days, VWO up two and a half — but if you look at the bond market, the signal is completely different. Yields are telling us a story that stocks are ignoring. Luna: Right, and I think that's the real story here. We talk a lot about equity flows, but the bond market is often the smarter money. So what exactly are the yields saying? Lucas: Well, let's start with a specific example. Look at Taiwan. The Taiwan stock market, the EWT ETF, is up over five percent this week — that's the best performer in our universe. But Taiwan's ten-year government bond yield has been creeping up, too, which suggests investors are demanding a higher risk premium. That's not what you'd expect if everyone was feeling great about the economy. Luna: So the equity rally is saying 'everything's fine,' but the bond market is saying 'hold on, there's more risk here.' That's a classic divergence. And it's not just Taiwan, right? Lucas: Exactly. South Korea is another one. EWY is up three point seven percent this week, but Korean bond yields have been under pressure too. And this comes after that big tech stock rout we talked about in a previous episode. So the bond market seems to be pricing in more volatility ahead, while equity investors are chasing the AI trade. Luna: Interesting. So maybe the bond market is more cautious because it's looking at the trade deficit. We saw the US trade balance improve slightly in June, but it's still a massive seventy-three billion dollar deficit. And the current account deficit is even wider. That's got to put pressure on emerging market currencies, right? Lucas: That's a good point. And here's the thing — the dollar is still strong. The trade-weighted dollar index is at one hundred nineteen point seven, basically unchanged. That makes it harder for emerging markets to service their dollar-denominated debt. So bond investors are pricing in that currency risk, while equity investors are maybe looking at the tech story instead. Luna: And the yuan has been stable, which helps China, but it also means the Chinese government is probably intervening to keep it that way. That can't last forever. Lucas: Right. And that's the crux of the divergence. In China, FXI is actually down a bit this week, and that's in line with the bond market's caution. But in Taiwan and Korea, the equity markets are roaring. So it's not just emerging markets as a whole — it's a split between tech-heavy exporters and the rest. Luna: So, for an investor, what does this divergence mean? Should they be worried about the equity rally in Korea and Taiwan? Lucas: I think it's a caution flag. When bond yields are rising while stocks are climbing, it often means the market is starting to price in higher inflation or higher interest rates down the road. And for emerging markets, that can be a double whammy — higher borrowing costs and weaker currencies. Luna: And we're seeing that in Brazil too. EWZ is down three percent this week, and that's not a coincidence. Brazil's bond yields have been elevated for a while now. Lucas: Exactly. Brazil is a great example because it's not a tech exporter. It's more commodity-driven, so it's more sensitive to global demand and the dollar. And when bond yields are high, it puts pressure on the equity market, especially if the central bank has to keep rates high to defend the currency. Luna: So the bond market is essentially saying that the easy money in emerging markets is over. We're not going to see a broad-based rally like we did earlier in the year. Lucas: Right. And that's why I think the bond market is the more reliable signal here. It's not just about yields, either. Look at the shape of the yield curve in some of these countries. In India, for example, the curve has been flattening, which historically has been a warning sign of slower growth ahead. Luna: But India's stock market has been resilient, right? INDA is up a bit this week. So even there, you have equities saying one thing and bonds another. Lucas: Exactly. And that's the pattern we're seeing across the board. The equity market is being driven by a handful of tech names, while the bond market is reflecting the broader economic reality. For most investors, that's a signal to be a bit more selective. Luna: So if I'm a listener who's thinking about putting money into emerging markets, what should I do? Should I avoid the tech-heavy markets? Lucas: I wouldn't say avoid, but definitely understand the risks. The tech rally in Taiwan and Korea is real, and it could continue for a while. But if you're looking at long-term, you need to watch the bond market. If yields keep climbing, that rally could be fragile. Luna: And it's not just about the countries themselves. It's also about the currency. If the dollar stays strong, that's going to be a headwind for all emerging markets, regardless of how good the tech story is. Lucas: Absolutely. And that's why the divergence is so important. The bond market is saying that the dollar isn't going away, and that means we need to be careful about currency risk. That's something that a lot of equity investors tend to overlook. Luna: So, to sum up, the bond market is the voice of reason here, and it's telling us to be cautious. But the equity market is still greedy. Which one should we listen to? Lucas: I think it's not about listening to one or the other. It's about understanding that they're telling different parts of the same story. The equity market is pricing in the potential of the AI boom and tech innovation. The bond market is pricing in the costs — the debt, the currency risk, the global imbalances. Both are right, but they're looking at different time horizons. Luna: So for the long-term investor, maybe the bond market is the better guide, because it's more about sustainability. Lucas: Exactly. And that's the takeaway I'd want listeners to have. If you're investing in emerging markets, don't just look at the stock charts. Look at the bond market. Look at the currency. Look at the trade deficit. That's where the real risks are. Luna: And speaking of looking at the real risks, you know what also helps with that? Having a clear head and not being distracted by ads. That’s something we’re pretty proud of on this show. Lucas: Yeah, that’s a good point. We keep this show completely ad-free, and that’s only possible because a small group of listeners chips in monthly through buy me a coffee dot com slash fexingo. It’s not a huge number, but it’s enough to keep us going and keep the analysis independent. Luna: And it really does make a difference. We don’t have to worry about pleasing advertisers, so we can tell you when we think something’s overvalued or risky, like we just did with these bond yields. Lucas: Right. So if you find value in these conversations, that’s the best way to support us. But back to the markets — I think the bottom line is this: the bond market is flashing a warning sign that we shouldn’t ignore. It’s not saying sell everything, but it’s saying be careful. Luna: And that’s a good note to end on. Thanks for joining us, and we’ll see you next time.