The expert magazine of Ostrum AM

Read analysis by Brigitte Le Bris, Clothilde Malaussène and Sébastien Thénard, EM fixed income managers at Ostrum Asset Management.

The brief calm observed on emerging market debt last month rapidly ended with new tensions on risk premiums, reaching the 370 bps (+43bps over the month of August and +85bps since the beginning of the year). Reasons are multiples, with in first position Turkey and Argentina concerns.
In Turkey, absence of clear economic solutions regarding the government strategy to fight inflation, combined with the low independence of the central bank caused (and strengthened) the decrease of TRY currency, which now enters in a vicious cycle.
At the same time in Argentina, despite IMF financing plan of 50bn$ over 3 years, the low level of Argentinian people’s confidence in institutions lead to sales on Peso versus Dollar, thus causing a currency drop.
Finally and more globally, commercial tensions between the US White House and the rest of the world (especially China) lead to fears on the World Trade degradation and an increase in the US inflation (trade barriers effect).
Impact was violent on FX developed and emerging markets, with an average depreciation of 5% on emerging currencies in August. The local debt index, the JP MORGAN GBI EM (unhedged in USD), decreased by -6.09% this month, with a YTD performance of -10.47%. The JP Morgan index for external debt has been a bit more resilient but still decreased by -1.73%.

What is the outlook?

In the upcoming months, the EM market should evolve according to the specific risks mentioned above (Argentina and Turkey concerns), encouraging to remain cautious. Furthermore, Brazilian elections will generate much interest due to the multitude of possible scenarios. In parallel and at a global level, commercial tensions should persist although the US Mid-Term elections and the next Fed meeting will be the major focus for autumn. Nonetheless, while the US economy remains robust, budget deficits and commercial balance deficit rises could weaken the US dollar. Stable US long term rates and less pression on EM FX would have a positive impact on international sovereign debt (in USD). Finally, the risk premium level at 370bps and the average yield to maturity at 6.6% already reflect the consideration of many of these uncertainties (both global and specific).