Capital Ideas^TM

Emerging markets (EM) bonds declined during the third quarter, posting modest losses across local and hard currency denominated sovereign issues. A hawkish stance by the US Federal Reserve alongside stalling growth in China weighed on the asset class. 

Inflation has rolled over across several emerging economies and the disinflationary trend is likely to continue, driven in part by the potential for ongoing suboptimal economic conditions in China. With inflation trending lower, several central banks across Central and Eastern Europe as well as Latin America have pivoted towards accommodative monetary policies.

The fundamental backdrop remains mostly supportive for EM debt. On balance, fiscal deficits have narrowed to pre-pandemic levels or lower and current accounts, a measure of foreign trade activity, are on a long-term improving trend. That said, the macro environment is less supportive as global growth outside the US may see a meaningful weakening.

Valuations on local currency bonds have become less compelling relative to US Treasuries; however, nominal yields remain high and inflation-adjusted yields are positive in select markets, particularly across Latin America. 

We favour owning some local duration across most regions as inflationary pressures continue to abate and monetary policies become more accommodative. We find less potential upside in EM currencies as valuations are fair. 

Hard currency bond valuations vary, screening somewhat expensive for investment grade sovereigns, cheap for high yield sovereigns and more middling for corporate issuers. We favour a balanced approach to owning hard currency sovereigns, blending bonds with lower overall volatility with select higher yielding distressed credit opportunities.

Across EM corporates, we find select exposures to issuers with strong fundamentals and positive credit stories continue to provide diversification benefits.