The environment for emerging market bonds is likely to get worse in the second half of this year, Bank J Safra Sarasin said it urged investors to pull in their horns in general amid an expectation that US bond yields to rise.

The environment for emerging market bonds is likely to get worse in the second half of this year, Bank J Safra Sarasin said it urged investors to pull in their horns in general amid an expectation that US bond yields to rise.

Weaker tolerance for risk and rising geopolitical risks (Ukraine, Middle East, etc) and the chance of a larger-than-expected rise in US Treasury yields make the case for holding emerging market debt less compelling, the Swiss private bank, with SFr131 billion of assets, said in a note.

According to its latest credit strategy, “The end of a good run?”, the bank maintains an overweight stance on Asia, which offers the best risk-adjusted returns and faces fewer macroeconomic and geopolitical headwinds. The bank is also constructive on Middle Eastern credits, which are trading at tight valuations but remain supported by the region’s higher credit ratings, gradual earnings recovery and lower returns volatility.

Bank J Safra Sarasin expects investment-grade corporate debt to outperform high yield, as spread differentials between the two segments are significantly below the historical average, implying that high yield spreads have further room (than investment grade) to widen from current levels.

“Emerging market corporates enjoyed a good run in the first half of 2014, the outlook for the second half is challenging as the era of easy returns draws to an end,” Dawn Sauter-Tang, credit strategist at the bank, said in the note.

“The entanglement of geopolitics with economics in particular has further increased the risks of EM, as seen in the case of Russia and Ukraine. In terms of regional allocation, we prefer Asia and the Middle East to Latam and Emerging Europe,” it said.

The least powerful “macroeconomic and geopolitical headwinds” are in Asia, the bank said, saying that India and Indonesia emerged from elections with market-friendly outcomes, while the Chinese government’s mini-stimulus measures seem to have stabilized growth in China to at least avoid a hard-landing.

Finally, reflecting on the clashes in east Ukraine, the bank said that while bond yields on emerging European debt are attractive in absolute terms, the political risks in the region make the market difficult to price.