Local rates provide a good cushion

The Emerging Market debt denominated in local currencies is one of the most attractive Fixed Income asset classes, with a yield at currently 6.7%.

Current yield levels provide a cushion against further local currency correction and core rate volatility. Many Emerging countries are facing lower inflation due to lower commodity prices or weak domestic demand. As a result, Emerging central banks are adopting a more accommodative stance by cutting policy rates. This could bring support for local rates. In particular, we continue to remain exposed to countries like Indonesia and Russia, where we expect rate cuts given the weak growth expectations. Regarding Russia, the decline in geopolitical risk should bring some relief on rates.

However, we remain cautious on local rates from commodity exporters like Peru, Colombia, Malaysia and countries whose central banks are in hiking rate mood (South Africa, Brazil).

Appealing risk/return features of external debt

External debt is displaying attractive features, with a spread versus US Treasuries fluctuating at around 340 bps. In a low-yield environment, we consider this spike in the spread as a good buying opportunity given the attractive risk/return features. We expect spreads to have tightened by 35 bps by year-end, on the back of solid fundamentals and supportive debt profiles. Technical factors are also positive drivers. Flows should continue to enter the asset class as they did in H1 (Chart 5). The low net new supply (i.e., new issues minus redemptions, about USD 2 bn.) is also highly supportive.

After a sharp performance, we have no exposure to Ukrainian bonds on likelihood of less friendly restructuring for private bondholder group increasing.

We acknowledge the Greek contagion spread to Eastern European debt. Even though many of these countries have limited commercial relationships with Greece, the risk-off environment has negatively impacted credit in a broadly undifferentiated manner. On a long-term horizon, we do not see any sustainable economic impact on these countries and are expecting spread tightening once an acceptable political solution is reached.

A defensive stance on local currencies

We still have a negative view on emerging currencies overall as we expect US dollar strengthening, driven by a hawkish monetary tone.

Our current cautious stance on emerging currencies translates into a long positioning on the USD. In that context, we are staying negative on the IDR given the weaker growth and reform momentum. The currency is also displaying high-beta FX. We remain negative on MXN – one of the currency proxies most used by market participants to hedge their Emerging Forex risk (as it is one of the most liquid). We remain notably negative on the ZAR given the weak growth and twin deficit.

On the “overweight” side, we like the CNY, as we consider that the depreciation trend of this PBOC-managed currency has come to an end. The CNY is also a low-beta currency and the country is still enjoying a large current-account surplus.