Strategist viewpoint: Zouhoure Bousbih, Emerging Markets Strategist
The near end of the Fed's monetary tightening cycle, and the surprise reopening of China have supported the emerging market debt (EMD) asset class since November 2022. The spread of the JPM EMBIGD index reached a nine-month low at 436 bps, after reaching 578 bps in October.
However, there are divergences based on sovereign ratings, as shown in the chart below.
Spreads of 'B' rated countries have still not returned to pre-pandemic levels, unlike 'Investment Grade' (IG) rated countries and countries rated 'BB' by S&P.
Those countries have sometimes significant international financing needs, but they have more difficult accesses to capital markets due to their borrowing costs in dollars which remain high (more than 10%). This year 2023 will be an important one for them, they could rely a little on the improvement of the world economic prospects. But the reaffirmed support of international financial institutions (IMF, World Bank), or countries (China, India, Gulf countries) is also more important than ever.
Finally, Commodity-producing countries should benefit from China's reopening, especially those producing industrial metals, such as Chile. The EMBIGD is a hybrid index, comprised of IG and HY sovereign issuers. The rating balance has changed significantly over the past 2 decades. In 2000, IG countries represented only 35% of the index versus 50% today. A higher weight in IG implies the index is more resilient to external shocks.
Portfolio Manager viewpoint: Sébastien Thénard, Senior global fixed income portfolio Manager
After a challenging 2022 (the worst since 1993), 2023 promises to be under better auspices. Already, the JPM EMBI Global Diversified Index is sending a clear signal, recording +3.17% in January.
We identify 6 reasons for the jump start:
- Investor risk appetite is increasing for asset classes like external EM sovereign debt (denominated in USD) as the US Fed’s tightening cycle moves into its final phase.
- The US dollar is no longer appreciating globally, leading to investor appetite for emerging market currencies.
- This new context for Risk and FX gives EM Central Banks’ room for leeway. We could see lower official rates in EM countries in 2023.
- Higher commodity prices can be a positive factor for EMD as it could imply better forward-looking credit quality for commodity producing countries. China’s reopening and the accelerating ‘Green Transition’ is supportive for energy prices and industrial metals.
- After record outflows in EMD bond funds (2022 USD90bn), 2023 has started with inflows (USD2.7bn).
- This year’s very active primary market has been well received by investors. Appetite is back. Net amounts for external sovereign EM debt will be remarkably low in 2023 which is supportive for the secondary market.
What about ESG & Social and Sustainability Linked sovereign bonds? A growing supply to come but already interesting investments (Uruguay, Chile).
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