Emerging market hard currency debt – that is, bonds issued by emerging market governments but denominated in US dollars – has performed resiliently this year. However, the impact of the coronavirus is felt across China, Asia and increasingly now the rest of the world.
The coronavirus has not been the only shock this year to disturb the serene narrative of a pick-up in global growth. Fears over tensions between the US and Iran escalated after the death of Qassem Soleimani on 3 January, only to fade very quickly. It is still too early to forecast the long-term economic fallout of the coronavirus. On 11 January, China identified its first death from a new type of virus, and on 30 January, with the death toll already in the thousands, the World Health Organisation declared a global emergency.
Since then, a consensus has been forming that the coronavirus, now named COVID-19, will have a more severe economic impact than SARS (another kind of coronavirus) did in 2003. For one thing, China now has a much larger share of world GDP than it had in 2003. For another, China’s growth model has evolved and is no longer running at the heady 10%-plus that it achieved then.
There is however a legitimate debate on how prolonged the impact of COVID-19 will be. The SARS epidemic triggered a sharp economic slowdown during the first quarter of 2003, but during the second quarter of 2003 growth quickly rebounded to trend due to intensive stimulus from all countries in the region. We think that in 2020 China will aim to bring growth back to trend as quickly as possible by wielding the monetary and the fiscal tools at its disposal. With other central banks and governments in the region following suit, we believe growth could indeed rebound quite strongly in Q2 or Q3 2020, but the market is likely to feel jittery in the meantime, with data expected to be terribly weak in the near term. Hence, we think our base case of a global growth pick-up is still valid for 2020, just that it will be delayed until the second half of the year.
While we shall continue to research and refine our views on the longer term impact of COVID-19 on global growth, it is already clear that the nearer term shock is quite severe for Asia. Thailand’s economy, with its reliance on tourism, is severely impacted, as is South Korea’s, due to disruption of its supply chains. The crisis gives most Asian emerging markets central banks an incentive to continue to cut rates: they have already acted in the Philippines, Thailand and Malaysia, while more is to come from Korea and Indonesia. This has given us room to rebuild our exposure to rates in the region, even though we have become more cautious on Asian currencies overall.
Hard currency opportunities emerging
Facing the COVID-19 crisis, emerging market debt was not immune to the global volatility. Performance has been mixed in emerging market local currency debt. Investors confident of a global growth spurt had positioned themselves in emerging market currencies, and some suffered as the economic implications of the coronavirus became apparent.
After the shock sell-off, we think attractive opportunities in emerging market hard currency debt should soon emerge. Yields on US Treasuries are now extraordinarily low. On 28 February, the yield on the US 10 year Treasury fell to around 1.19%, and on the 30 year it was below 1.7%, a record low. Such rock-bottom yields reflect both US economic data and dismal investor sentiment. However, we think flat-on-the-floor yields should eventually drive investors to search outside developed county issuers, and therefore favour emerging markets. From a valuation point of view, high yield names have corrected significantly with some close to or undershooting the 2018 lows. In contrast, investment grade names have reached historic low spreads, leaving little buffer to outperform.
Given the uncertain economic outlook, we have been concentrating on countries we like independently of the global risk environment.
One such country is Ghana, which has been pursuing macroeconomic stability with an improved fiscal position. We view its hard currency bonds as still relatively cheap on the fundamentals. Ghana’s current account balance should benefit from higher gold prices; meanwhile, lower oil prices are somewhat offset by marginal gains in oil production.
To be sure, Ghana has struggled during the last couple of years. Both its banking and energy sectors needed bailing out, and although the latter is still underway, we feel the government has adequately provisioned for it. We do not expect a major departure from fiscal projections, and see little risk of major fiscal slippage ahead of the elections in Q4. We therefore maintain a strong overweight to Ghana.
We think the next big reform story could be in Pakistan. The sharp devaluation in Pakistan’s currency has allowed for a quick correction in its current account balance. Pakistan’s fiscal position, still its weakest link, should improve as it aims to meet IMF targets.
We also continue to like low beta, high quality credits such as Indonesia, Russia and – more recently – Uruguay. In Russia, scarcity of dollar-denominated debt and strong fundamentals continue to push valuations to all-time highs. In Uruguay, the incoming government has put forward a fiscal reform agenda and growth is expected to pick up thanks to stronger economic management.
We also continue to see better value in the new frontier space where the rate cutting cycle has more to go (and real yields are still very high). We continue to like Ukraine and Egypt, where more substantial rate cuts are expected; but we have turned more cautious on Nigeria given its dependence on oil. We also like Pakistan T-Bills which offer a good carry with expectations of a stronger currency now that the country’s current account has adjusted.