Emerging market debt went through a long overdue correction in February, but the overall macro story remains very supportive of the asset class.
Stronger growth was reported across the spectrum (including in major economies like Russia or Brazil), while narrower current account deficits and the rebuilding of FX reserves continue to point to reduced external vulnerabilities. Inflows into the asset class have also remained positive, barring a week of ETF-related outflow, showing that a wider audience continues to buy into emerging market (EM) investors’ optimism about the asset class. Admittedly, hard currency valuations had become very stretched in January, with the spread vs US Treasuries falling below the psychological 3% threshold.
Some value has been re-created since then, especially in longer dated bonds, but sentiment has remained very jittery with question marks around the term premium and the US dollar going forward. Long-dated new issues have done relatively well, with US$10bn+ books showing there is cash to be put to work on bonds offering a 30 basis point discount to curves that have already cheapened by 60 to 100 basis points for some. But any attempted rally in March has so far remained very fragile, showing the difficulty for the market to recalibrate the new EM risk premium. In short, we still like the story, we potentially see value here, but there is still some uncertainty as to how much should US Treasuries re-price to account for a much bigger fiscal boost in the US and its inflationary impact. Adding in the impact of likely trade tariffs on growth and inflation makes the overall macro picture even more blurry.
In that context, we favour relative value trades and concentrate on improving credit stories with limited risk of near-term supply like Argentina, Brazil or new issues like Egypt and Nigeria. Deteriorating credit stories like Sri Lanka or Pakistan are much less compelling.