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Fixed Income
Emerging markets (EM) bonds had another strong second quarter, posting gains across both local and hard currency-denominated sovereign issues. An unexpectedly favourable macro backdrop in much of the developed world provided support for risk assets. In particular, a resilient US economy amid easing inflationary pressures may soon allow the US Federal Reserve to conclude its interest rate hiking cycle. Conversely, weaker-than expected economic data from China tempered expectations that the country’s reopening would provide a tailwind to emerging markets.
Regional results were mixed for local currency-denominated bonds, with notable strength observed in Latin America, led by double digit gains in Colombia and Brazil, according to components of the JPMorgan GBI EM Global Diversified Index. Issuers in Asia and Africa modestly declined.
Sub-investment-grade issuers underpinned positive results for hard currency sovereign bonds, while investment-grade bonds posted more muted gains according to the JPMorgan EMBI Global Diversified Index. All regions advanced during the quarter.
As inflation continues to moderate across numerous emerging economies, we believe a downward trend in policy rates is likely to follow. This combined with decent fundamentals, relatively attractive nominal rates and positive real rates across many EM countries, leads us to a favourable medium-term view of the asset class. That said, selectivity still reigns given the divergence in policy and inflation dynamics across countries, as well as varying relative and absolute valuations across issuers.
We see the most value in local Latin American issuers, but select European sovereigns also look attractive. Despite recent gains, a broad basket of EM currencies appear undervalued relative to the US dollar. The combination of reasonably attractive local rates markets and cheap currencies lead us to favour a slight tilt toward local EM debt.
We favour a mix of credit qualities across hard currency sovereigns to take advantage of perceived market mispricing of select distressed issuers while balancing those risks with exposure to lower beta investment-grade sovereigns. EM corporate bonds may provide diversification benefits.
Many EM currencies have gained against the US dollar
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As at 30 June 2023. US dollar, euro and British pound reflects the difference in return between the JPMorgan GBI-EM Global Diversified Index in local currency and the JPMorgan GBI-EM Global Diversified index unhedged in either USD, EUR or GBP. Sources: JPMorgan, MorningStar Direct
Inflation-adjusted yields considered attractive in select markets
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As at 30 June 2023. The real yields shown are the differences between the yields for the respective countries in the JPMorgan Emerging Markets Global Diversified (GBI-EM) Index less core inflation in the country. Source: JPMorgan
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