Capital Ideas^TM

Bonds across emerging markets (EM) saw mixed results during the first quarter of 2024. Hard-currency-denominated debt notched moderate gains, while local-currency-denominated bonds declined modestly in US dollar terms.

High-yield hard-currency credits posted positive results during the period, led by gains across the majority of African issuers. Conversely, high-grade US dollar-denominated issues fell due largely to weakness across Middle Eastern credits.

Local currency-denominated bonds declined across all regions during the quarter, with African and Middle Eastern issues seeing the most significant losses. South African sovereign bonds came under particular pressure due to uncertainty around the country’s upcoming elections and the potential timing of central bank rate cuts.

Looking forward, fundamentals across many emerging market economies remain relatively healthy and inflation rates are largely trending lower due to aggressive policy actions by central banks early in their inflation cycles. Though policymakers across some economies have recently pivoted to rate cuts, real rates (nominal interest rates less inflation) continue to be mostly positive.

Growth rates throughout a number of emerging economies continue to outpace their developed market counterparts, with largely similar fiscal deficits and mostly lower sovereign debt levels. Likewise, reasonably high commodity prices post-COVID have supported emerging market external balances and reserves. 

A potential soft economic landing in the US could benefit emerging markets. Still, that outcome remains uncertain, which, alongside growth headwinds from China and a number of geopolitical risks, contributes to our more cautiously constructive view. Though fundamentals are mostly supportive and relative valuations look reasonable, a balanced approach to risk is key given these potential catalysts for volatility.

Within EM local markets, currencies have become somewhat less attractive due to their broad-based rally in 2023. We favour owning some duration in many of these markets due in part to the pivot toward more accommodative monetary policies. 

We find that US dollar-denominated EM debt continues to offer some value in the lowest quality/distressed segment of the high-yield market, but on a more idiosyncratic basis. Still, spread levels in BB-rated high-yield credits have become less compelling. The investment-grade segment of the market, particularly BBB-rated credits, appear attractive compared to equivalently-rated US investment-grade corporate bonds. 

Lastly, select EM corporate bonds continue to offer reasonably high yields and geographical diversification benefits to portfolios. Fundamentals across many of these issuers likewise remain sound.