Emerging Market Debt (EMD) is enjoying a “favourable” start to 2024, with growth, falling inflation and monetary easing trends across emerging economies acting as tailwinds for the debt class, according to Euart MacKerron, fixed income investment analyst at Aegon Asset Management.
Emerging markets should provide the opportunity for another year of positive returns following a successful 2023 for EMD, writes MacKerron. This “solid foundation” is reinforced by the Federal Reserve’s pivot in December to end their hiking cycle which should support growth through policy easing later in 2024, especially as US inflation shows signs of moderation.
Speaking to The DESK, MacKerron said, “After two years of significant outflows from the asset class, expectations of investor appetite returning in 2024 have built. Yet this is largely contingent on realisation of the Federal Reserve easing policy rates and the attractiveness of low-risk money market funds, which may be pushed into late 2024. In the interim, lacklustre fund flows – likely in the red – may persist, driving some underperformance of the higher quality cohorts of EMD which already trade at relatively tight levels.”
In an analyst note on the sector, he highlights high yield corporates from regions such as Brazil, Colombia and Turkey as the most compelling.
“Brazil and Colombia offer the best opportunities within Latin America and Turkey has issued many interesting opportunities in the past six months,” MacKerron said. “Particularly, fundamentally robust BB-rated corporates which have lagged the spread tightening of their sovereign counterparts since early 2023.”
Turkish corporate bonds look compelling relative to sovereign bonds having historically traded tighter to reflect a combination of dollarized export earnings, offshore liquidity and foreign sponsors, which provide some shelter to any return of politically induced volatility there. “Ukrainian corporates have been another favoured sector, though bond prices are now reflecting their remarkable capacity to adapt to the shifting operating environment.”
“However, a considerable portion of this optimistic shift is already reflected in EM bond pricing, particularly in sovereigns where credit spreads of investment-grade bonds are trading near decade lows. Despite these positive indicators, some caution is warranted. The upward revisions to global growth forecasts are primarily driven by US exceptionalism rather than broader synchronisation,” MacKerron said.
“If this trend persists over an extended period, it could eventually exert pressure on emerging market currencies, prompting policymakers to slow down their easing cycles and thereby impeding growth.”
However, MacKerron does not anticipate a significant tightening of the headline credit spread for the asset class from its current levels.
“Nevertheless, within the asset class, ample opportunities exist for investors to align with a more optimistic outlook and potentially achieve higher returns.”
MacKerron also highlighted “attractive opportunities” in resilient telecommunications and related infrastructure in frontier jurisdictions, which are exhibiting favourable market trends in marked contrast to the saturated telecoms markets of the Americas and Europe.
He believes within sovereign EMDs, the opportunities are more “idiosyncratic” as performance has struggled relative to US credit in the past few months.
“Within sovereigns, opportunities are more idiosyncratic. The underperformance of BBB-rated sovereigns relative to US credit since mid-2023, exacerbated by last month’s heavy supply, has provided better entry levels for Romania through primary markets. Ivory Coast is one of the few fundamentally positive stories on the African continent at this juncture, having broken the two-year bond issuance hiatus for SSA sovereign issuers. Most value resides in CCC-rated and restructuring sovereigns, despite last year’s very high returns.”
“As the IMF and bilateral lenders have stepped in, fears of a sharp wave of sovereign defaults following the successive economic shocks from 2020-22 have calmed. A few stressed issuers, such as Pakistan, are now likely to remain current into at least 2025 which should offer further upside. Lastly, those concluding their debt restructurings such as Ghana will likely be conducive for investor returns,” MacKerron concluded.
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