Ken Leech, CIO from Western Asset Management, said that while the global growth situation has not developed into recession, it warrants exceptional monetary accommodation.
He said policymakers have to be attentive to downside risks, especially in an environment where global inflation remains exceptionally subdued.
‘Fortunately, central bank accommodation is aggressive and increasing. That means US Treasury bonds and sovereign bonds will be underpinned by these low policy rates, which will continue around the world,’ Leech said.
In this article, Citywire Asia canvasses the views of fixed income experts on what they are backing in EM debt and why they believe it presents a good opportunity.
Luca Paolini, Pictet Asset ManagementChief strategist
Emerging market hard currency debt is benefiting from three key factors: moderating US rate expectations; the search for yield; and stabilising EM fundamentals.
First, notwithstanding the strength of the US’s labour market, the Fed has become increasingly dovish in light of geopolitical risks like Brexit and signs of weakness in global trade. This shift in expectations has helped trigger a rally in T-bonds which has, in turn, lifted dollar-denominated EM bonds.
Second, investors are increasingly desperate for income. Around a third of all developed government debt is posting negative yields and even some corporate yields are negative.
So the spreads of around 360 basis points offered by EM debt over T-bonds are attractive. Particularly so given it is a sovereign asset class with exposure to over 65 different countries, no direct currency risk and an average credit rating just one notch below investment grade.
Third, fundamentals appear to have stabilised. Commodity prices - a major source of EM income - have recovered somewhat. And China appears to have weathered some recent economic challenges with fresh rounds of monetary and fiscal support.
EM exports have bottomed out and we have seen some green shoots such as in Asia, which has benefitted from an earlier decline in commodity prices as it brings down the cost of manufactured exports.
Treasury bonds remain the dominant force for EM hard currency debt, accounting for around two-thirds of the market’s performance this year. The remaining third comes from yield compression with spreads having come in from 500 basis points.
Ricardo Adrogue, Babson Capital ManagementHead of emerging markets debt and
Brigitte Posch, Babson Capital ManagementHead of emerging markets corporate debt
We believe attractive opportunities will continue to materialize in EM debt over the next 12+ months. Even after rallying through the first half of 2016, EM currencies remain at some of their most attractive levels in more than ten years.
Despite prolonged accommodative monetary policy in both developed and emerging markets, EM growth has been tepid and inflation has continued to fall in many countries.
However, we continue to see opportunities across EM sovereign debt, particularly in countries with strong governance and solid policy frameworks.
Our outlook for EM corporates is more constructive following the broad-based rally in the first half of 2016, as many of the factors that have been weighing on the asset class—low energy, foreign exchange fluctuations, commodity prices and weak global growth—now appear more stable.
Moreover, as EM corporates focus increasingly on deleveraging and liability management, we believe corporate balance sheets will be more resilient to potential volatility in currencies and commodities.
Going forward, supportive technicals and continued accommodative policy should also continue to provide stimulus to the asset class.
The impact of Brexit on EM will bear watching. In the short term, we believe the impact may be moderately negative, as it will likely result in global economic deceleration and weaker market performance.
Longer-term, the issue may be a relative positive for EM and highlight the independence of EM political and economic institutions.
Ken Leech, Western Asset Management
There is a real case to be made for emerging markets, both in local currency and dollar-denominated bonds. That's an area we are focusing on even more meaningfully than coming into the year. The yield spread between EMs and developed is now very wide.
When you think about valuations and people needing yield, this is where yield is abundant. The two positions we have liked structurally have been Mexico and India.
Over the course of the year we have been opportunistically investing in a number of others. One I'd highlight is Brazil.
The EM widening against developed market yields really provides an opportunity, but that opportunity exists due to weak global growth, challenging commodity prices and a lot of volatility. You have to be real thoughtful about your proportionality and do your homework.
That is the backdrop for a remarkable change both in the currency and the local interest rate environment, and even in their corporate debt. We continue to be positive on their turnaround.