Emerging Market Debt in local currency: remain OW


In this month’s View of the CIO, Peter De Coensel, CIO Fixed Income, sheds some light on the Emerging Market Debt segment in local currency.

De Coensel: “We expect core 10y EMU rates to remain anchored below 1.00% over the next 12 months. Essentially this ‘low for longer’ base case scenario is built on the growing conviction that central bank QE programs will remain in place for a long time. US 10-year rates contain value around 3%.

QE programs will never get fully reversed. Aggregate central bank balance sheets will continue to exert substantial influence on the demand/supply equation and resulting rate setting process across global bond markets. The US Fed is thus temporarily reducing the size of its balance sheet. After 7 rate hikes, 8 next month, we are closing in towards the end of the rate cycle in the US. At the start of the summer the newly appointed and voting New York Fed Governor Williams stated he sees the neutral Fed rate at 2.5%. I agree. We’ll reach that level with one additional rate hike after the September hike. When the Fed goes beyond that level, towards 2.75% to 3%, it should have a cooling effect on the US economy. Jay Powell will finish on the current rate hiking cycle before the ECB starts normalizing rates in baby steps by the end of 2019.”

How are emerging market bond markets faring against this backdrop?

“While it is true that in recent months specific elements have led to a sell-off in currencies in Argentina, Russia and Turkey, there were only few signs of contagion towards other EM countries with credible monetary and fiscal policies, we assess the setbacks as temporary. For the majority of countries we select based on our sustainable framework, we observe fundamental improvements. Some examples are Indonesia, Czech Republic, Brazil or Mexico.”

De Coensel adds: “Uncertainty and resulting volatility given the remaining political calendar out of key emerging economies will persist. Nonetheless, the DPAM global asset allocation framework, puts an overweight for this segment because of the compelling longer term value features. We observe the highest EM-DM real rate differentials since 2011. On top we note improving relative term premiums between the US and EM that act as an important buffer for EM in an overall context of sustained growth and improving external balances for the majority of EM economies.”

De Coensel concludes thus that “valuations in EM local currency debt have become increasingly attractive on all relevant investment horizons”


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