It’s been a good year for emerging market debt, and macro-economic conditions look promising for next year.
The emerging market debt index, JP Morgan EMBI Global Diversified Index rose 13% this year to the end of October after declining last year, while the emerging market (EM) local-currency index, the JP Morgan GBI EM Global Diversified index rose 11%, also following a decline last year.
For much of 2019, the market has been oscillating between fears of recession, a negative for risk assets and emerging markets in particular, and a more dovish US Federal Reserve (Fed), with rate cuts being a positive for carry and therefore emerging market debt. Markets now appear to be positioning for some growth recovery, helped by signs of progress in US-China trade talks.
End of Strong Dollar?
We do not believe that the US will enter into a recession next year but is instead normalising to trend growth after the “sugar rush’’ of 2018. The data in emerging markets, though not stellar, is showing some green shoots, indicating that central bank easing and fiscal stimulus has taken hold. As a result, emerging markets may grow faster than developed markets and the US in particular, signalling the end of the strong US dollar cycle. Hence, although the big move in rates seems largely done, the value next year should come from the long-awaited recovery in EM local currencies.
We also see more upside in frontier markets next year, where the central banks have lagged the global easing cycle. The most value is in countries with high carry and high real rates as central banks will have room to cut rates. Egypt and Ukraine, for example, have performed well this year and have further to go, we believe.
Gabon, Ghana, Nigeria
A normal, slow global economic recovery also would bode well for commodity-producing nations, including oil exporters, and in the hard currency space countries in sub-Saharan Africa such as Ivory Coast, Gabon, Ghana and Nigeria, where valuations appear cheap.
In Latin America, we expect volatility to pick up as more governments face social protests after years of sub-par growth and attempts at fiscal austerity. In that context, Brazil stands out as an oasis of stability, with progress on fiscal reform enabling private investment and leading to upward revisions in growth forecasts. In Central and Eastern Europe, growth continues to soften alongside weaker activity in the EU, although Turkey has managed to smooth out the downturn, albeit at a heavy fiscal cost.
There are risks to the global recovery view, of course. These include trade war-related disruption or that the US recovers more quickly than the rest of the world or even that the US slides into recession – though this seems unlikely in an election year.
Right Time for Local Currency?
We see similarities between current economic conditions and the cycle of 2016-2017, where slow stabilisation and transition in 2016, similar to this year, were followed by growth and recovery in 2017, which was a record year for inflows to the asset class, at around US$61bn, versus around US$30bn so far this year. 
Investor flows have been increasing into hard currency EM debt, and the asset class is less cyclical than some may believe. With returns close to developed market equities and less volatility, we view it as a core holding in a well-diversified global portfolio. Given next year’s outlook, EM local currency debt could finally outperform hard currency.
With the Fed on hold and green shoots showing global growth recovering slowly, we think EM debt will look even more compelling in 2020 and attract strong inflows.
 Source: EPFR Global, Standard Chartered research as at 6/11/2019