July 18, 2024

Emerging markets (EM) bonds produced varying results during the second quarter. Local-currency-denominated-bonds experienced declines in US dollar terms, while hard-currency-denominated debt achieved moderate gains.

Local-currency-denominated bonds declined across most regions during the quarter, with Latin American issues producing the most noteworthy declines due to weakening local currencies relative to the US dollar. Mexican bonds came under particular pressure after Mexico’s outgoing president and his successor vowed to push forward with a series of controversial reforms.

High-yield hard-currency credits generated moderate returns as they benefitted from tighter spreads and a strong income profile. Similarly, high-grade US-dollar-denominated bonds advanced, driven by carry and tighter spreads.

Notable emerging markets spreads, yields and currencies

Investors have largely priced out recession scenarios

Data as at 30 June 2024. Sources: Bloomberg, JPMorgan
1. Figures reflect spread to worst on the IG component of the JPMorgan Emerging Markets Bond Index (EMBI) Global Diversified index.
2. Figures reflect spread to worst on the HY component of the EMBI Global Diversified index.
3. Figures reflect the EMBI Global Diversified index.
4. Figures reflect yield to maturity on the JPMorgan Government Bond Index - Emerging Markets (GBI-EM) Global Diversified index.
5. Figures reflect the GBI-EM Global Diversified index.
6. EMFX reflects the JPMorgan ELMI+ Index. The index is a proxy for EM currency performance in US dollar terms.

Looking forward, fundamentals across many EM economies remain relatively healthy. Inflation has largely trended lower due to aggressive central bank actions early in the economic cycle. However, this downward trend has met some resistance in select markets as sticky prices and higher-than-expected inflation figures have led some central banks to pause interest rate cuts. Despite these headwinds, real rates (nominal interest rates less inflation) continue to be mostly positive.

Inflation-adjusted yields remain mostly positive across regions

*Turkey was –26.6%

As at 30 June 2024. The EM real yields shown are the differences between the yields for the respective countries in the JPMorgan Government Bond Index — Emerging Markets (GBI-EM) Global Diversified index less core inflation in the country. The US real yield shown is the five-year US Treasury yield less core inflation. Sources: Bloomberg, JPMorgan

Growth rates have slowed modestly across a number of emerging economies but continue to outpace their developed market counterparts. Additionally, emerging economies have largely maintained more favourable growth-to-debt dynamics than developed markets. Elevated commodity prices post-pandemic have been supportive for EM.

Uncertainty in the global economy, slow growth in China and heightened geopolitical risks surrounding a substantial number of elections in 2024 have led us to remain cautiously constructive on the asset class. While fundamentals are broadly supportive and valuations appear reasonable, we believe a balanced approach to risk is essential given the potential for increased volatility.

EM local currency valuations have become somewhat more attractive as the US dollar strengthened in the first half of 2024. Still, we remain cognisant of near-term risks as sticky inflation or less accommodative policy decisions from central banks could lead to fewer interest rate cuts in 2024.

We continue to find value in lower rated and distressed hard currency denominated debt. These tend to be idiosyncratic credits where valuations have diverged from fundamentals, thereby creating an attractive risk premium. We’re also finding value in the investment-grade BBB-rated sovereign segment of the market, which continues to offer an attractive spread premium relative to similarly rated US credits. Finally, select EM corporate issuers continue to offer reasonably attractive yields while providing diversification benefits relative to sovereign credits.