Outlook for Emerging Market Debt – Javier Arias, Redington

by | Oct 26, 2022

Javier Arias, Vice President, Manager Research, at Redington comments:

“The first half of the year was extremely challenging for Emerging Market assets, with the most widely used EM Fixed Income Indices in the sovereign and corporate space delivering between -14% and -20% YTD (as of June 2022) and spreads widening more than 300bps in the case of EM high yield corporates.

“That said, having spoken with some our preferred managers in this asset class over the last couple of weeks, there now seems to be a high degree of optimism for Emerging Market Debt (EMD) over the next 12 months. According to them, the scale of this year’s drawdown has left a more favourable return profile for the asset class, as volatility begins to ease down, and inflation shows signs of stabilising in certain regions (e.g. Real interest rates adjusted for expected inflation over the next 12 months are now positive in key countries like Brazil, Chile, Colombia, Peru, Hungary and India).

“However, while the outlook is favourable for EM rates and to some extent for EM credit, expectations for EM FX are more muted, given the sustained strength of the US dollar. EM rates are expected to benefit from the fact that many EM Central banks began hiking rates a full year prior to the first Fed hike, which means certain banks are now near the end of their hiking cycles.

“In terms of EM Credit, managers maintain a selective view on the back of default risk remaining at elevated levels, but at this point is worth highlighting that while the YTD default rate in EM corporates is close to 10%, if you take Chinese property and Russian corporate names out of the equation, that rate becomes 0.2%.

“Lastly, when it comes to EM FX, despite some currencies benefiting from elevated commodity prices, managers believe that the prevailing strength of the US dollar severely hinders the return expectations for this segment as the Fed’s hiking cycle continues.”

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