Global emerging market debt – the macroeconomic outlook

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Each month the global emerging market debt team meets to discuss the macro-economic environment and draw conclusions about how we anticipate it will influence the EM debt universe. Here is a short summary of our most recent analysis on 2 February 2018:

Despite the rise in US interest rates, the data is indicating that output in the US economy is surging again…

US manufacturing production (year-on-year, seasonally adjusted)

Source : BNP Paribas Asset Management, as of 02/02/2018

US exports, year-on-year, seasonally adjusted

Source : BNP Paribas Asset Management, as of 02/02/2018

Leading indicators in emerging markets suggest that stronger growth is making itself felt – the spread between purchasing manager indices (PMIs) in the developed markets (DM) and those in emerging markets is narrowing:

Developed markets composite PMI / EM composite PMI spread

Source: Eikon Datastream, as of 01/02/2018

The trend in EM economic growth is now the best since 2010:

GDP Growth in EM ex-China (quarter-over-quarter, %, seasonally adjusted annual rate)

Source : Haver Analytics, own calculations, through Q3 2017

Regime change?

Our analysis suggests that the correlations between the hard currency (USD) debt universe for emerging market debt and the local currency universe are changing. The table below shows changes in a number of correlations between the emerging market debt denominated in US dollars (EMBI) and emerging market debt in local currencies (GBI)

 

Source: BNP Paribas Asset Management, as of 02/02/2018

In every year since 2010, emerging market bonds denominated in local currencies underperformed emerging market debt in US dollars. In 2017, for the first time since 2010, local bonds outperformed as their currencies strengthened versus the US dollar. Emerging market debt in local currency were the best performing fixed income asset class in 2017 returning 15.21% (JP Morgan GBI-EM Global Diversified Index). In our view this is likely to be the start of a multi-year trend with local currencies recovering after their period of underperformance relative to the US dollar between 2011 and 2016…

Performance of EM local currencies versus US dollar, 2003-05/02/2018

Source : BNP Paribas Asset Management, as of 02/02/2018

In summary, we draw the following conclusions from our analysis:

  • US, eurozone and China – a slow turn from easing to tightening of monetary policy is underway but the growth/monetary policy mix remains EM supportive
  • EM growth momentum in 3Q17 has ticked higher and the sequential trend is the best since 2011. This should be supported by the rising trend in DM growth…
  • …while EM inflation is gently rising from historically low levels

Main risks for 2018 for emerging market debt:

External factors

  • A rise in DM inflation forcing DM central banks to tighten faster than anticipated
  • Volatile commodity prices (disruptive for commodity exporters and importers)
  • Uncontrolled economic slowdown in China

Domestic factors

  • Inflation rising (implying end of easing/start of tightening by EM central banks)
  • Heavy political cycle with risks to reforms and investment; shift to populism
  • Idiosyncratic EM-negative stories to watch: Turkey credit-driven growth comes to a halt, demise of NAFTA for Mexico.

And here is the summary of our views for each of the principal investment activities within the emerging market debt universe:

We are at a neutral 50:50 asset allocation between EM debt denominated in local curencies and hard (US dollar) denominated debt. This belies active positioning in the underlying debt markets.

Source: BNP Paribas Asset Management, as of 02/02/2018

In summary, the Global EMD team has decided tactically to neutralise the overweight in local currency EMD, offsetting a Forex overweight with an EM rates underweight. The team repositions after a strong January into 50%/50% of hard versus local currency.

  • Tactical overweight US Treasury in hard currency portfolios
  • Neutralise FX risk with EM rates underweight
  • We begin to position for inflation in 2018

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

L. Bryan Carter

Head of Emerging Markets Fixed Income

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