Opinions, estimates, forecasts, projections and statements of financial market trends are based on market conditions at the date of the publication, constitute our judgment and are subject to change without notice. There can be no guarantee they will be met.
19 May 2023
EM local debt is catching the eye
Emerging market (EM) local currency debt has performed well year to date and we believe the developed vs emerging market dynamic, as well as macroeconomic conditions will help the asset class continue delivering healthy returns for the remainder of year.
Fundamentals
The market’s focus on persistent inflation has begun to fade as disinflationary trends build in both developed and emerging markets alike. We expect this shift to continue with EM disinflation accelerating, powered by robust monetary policy tightening from EM central banks earlier in the cycle. Following that aggressive tightening path, conditions have shifted into more growth restrictive territory, which has in turn led to economic activity cooling. Also helping to bring down inflation are lower global commodity prices, as the initial price shock from the Russia-Ukraine conflict has subsided. For the coming months, we expect base effects to contribute to a considerable reduction in headline inflation rates, given consumer price index readings in April-June 2022 were particularly strong.
Quantitative valuations
While each EM region and country offers distinct and sometimes idiosyncratic characteristics, we note both nominal and real interest rates across emerging markets are appealing at present. This is due to elevated EM base rates which have resulted in EM local rates appearing cheap relative to history. This is only half the story, however. Given they were earlier to raise rates in the cycle, we expect to see EM central banks begin to cut rates before their developed market peers. This would be a rare feature were it to occur, one that is rarer still if it were to occur at scale. A weakening in the trade weighted dollar might further compound this trend.
Yields across emerging markets trading at attractive levels
Source: Bloomberg, as of 17 May 2023. *Ex-ante 10 year real yields based on average 2023, 2024 Bloomberg inflation expectations.
Technicals
Further supporting our positive stance towards emerging market local rates is an encouraging technical backdrop. Emerging market debt suffered USD 90 billion of outflows in 2022, making it one of the worst years of outflows in decades, as core yields and short rates rose. This feature has contributed to some of the lightest investor positioning we have seen, with EM foreign exchange (FX) and EM rates substantially underrepresented in portfolios. It is fair to say that foreign investor interest – and thus exposure – has been elsewhere, with many markets almost entirely driven by the local bid. For this reason, we see considerable room for yields to rally, given the relative value available in emerging markets at present.
What does this mean for fixed income investors?
Last year’s anticipation of an ongoing EM local yield rally throughout 2023 has held true to this point and we think that there is more to come for the asset class. EM local valuations are attractive, with nominal yields ranging up to 13% and real yields up to 7% (as of 17 May 2023). A softer US dollar and market expectations for rate cuts by the Federal Reserve later this year offer potential catalysts to the trade, thus supporting the EM FX component. Combining this with relatively stronger fundamentals than those seen in previous cycles, as well as a positive technical backdrop, EM local currency debt may be set up for a strong performance in absolute and relative terms versus other fixed income sectors.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors
include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations
is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors
are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum
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