Why the EM bond rally is different this time

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Shrinking spreads between emerging market bond yields and U.S. Treasurys' may have spurred bubble fears, but some analysts don't see any reason for alarm.

"We are not convinced that there is a big bubble in the prices of emerging market dollar-denominated bonds that will burst soon," John Higgins, an economist at Capital Economics, said in a note Monday.

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Funds have certainly rushed back into the segment, with around $9.13 billion flowing into emerging market bond mutual funds and exchange-traded funds over the past three months, according to data from Jefferies. That's pushed yields lower as bond prices move inversely to yields.

Higgins noted the bubble fears are coming from data showing the "stripped " spread, or the spread excluding collateralized flows, between the yields of the JPMorgan EMBI+ index and U.S. Treasurys recently dipped below 275 basis points, the lowest in over a year. The EMBI+ index tracks actively traded U.S. dollar-denominated bonds and traded loans issued by sovereign entities in emerging markets.

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But Higgins added that the spread remains well above its trough of around 150 basis points touched in June of 2007, just before the financial crisis. While an increase in spreads from some troubled index members, such as Argentina, Ukraine and Venezuela, may be distorting the aggregate level, only one constituent -- Ecuador -- has actually seen its spread fall since 2007, he said.

While mid-2007 spreads, which generally marked the pre-crisis lows, couldn't be considered "normal," neither should the much higher 700-800 basis point levels seen in 2000, he said.

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"The average credit rating of the constituents of the EMBI+ has risen from around BB- then to BB+ today, reflecting a general improvement in macroeconomic fundamentals and debt dynamics," Higgins said.

To be sure, Capital Economics isn't convinced it's time to pile in.

"We doubt the rally will continue, but don't think the spread is likely to balloon," Higgins said. "Our forecast is that it will end next year at 315 basis points, as a gradually less accommodative Federal Reserve dulls investors' appetite for risk."

Others remain bullish on emerging market fixed income.

"The overall environment for yield-hunting remains quite favorable, in our view, reflecting the policy signals from both the Fed and the ECB," Societe Generale said in a note last week. But it added that it's being more selective.

"When adjusting for inflation, a number of local rates markets – in the long end— continue to show some value," it said, adding that any market producing a real yield above 3 percent would be "quite attractive" by this metric. The group includes Brazil, Hungary, Colombia, Romania and Poland, while Turkey and Chile look unattractive, the bank said.

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Societe Generale also expects bonds from emerging Europe will benefit from a "substitution" effect as euro zone peripheral assets begin to look overstretched.

Investors should also consider switching currency when looking at emerging market bonds, as euro-denominated papers should continue to outperform U.S.-dollar denominated ones, it said.

While the Fed is turning off the taps by tapering its asset purchases, euro zone monetary policy is likely to remain more accommodative, helping to support euro-denominated emerging market assets, it said.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1