- Fixed Income Portfolio Manager
Luxembourg, Intermediary
ChangeThe views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
The emerging markets (EM) local debt sector (as measured by the JP Morgan Government Bond Index – Emerging Markets Global Diversified) just posted its worst calendar-year performance since 2013, returning -8.75% against the headwind of higher EM local interest rates. The underlying culprit? EM inflation surprised to the upside in 2021, forcing a number of EM central banks to raise their policy interest rates in an effort to curb the impact.
Although overall EM inflation did not look materially different from that of the developed world last year, the policy response as of this writing has been starkly different: EM central banks as a group have hiked policy rates aggressively, whereas the US Federal Reserve (Fed) and other developed market counterparts have scarcely budged rates from the zero-bound range (Figure 1). So what now?
Figure 1
It’s all (or mostly) about EM inflation
Many clients have asked us lately if the EM local debt sector’s poor recent performance is likely to persist through 2022. We don’t have a crystal ball of course, but there are good reasons to believe elevated EM inflation (and by extension, rising EM local rates) may prove to be more of a transitory — less “sticky” — phenomenon than in the developed world:
- EM inflation tends to be very heavily influenced by moves in commodity prices, which represent a meaningfully larger portion of the total consumption “basket” for many EMs than they do for developed markets. While commodity prices may continue on an upward trajectory in 2022, we think their year-over-year change is unlikely to be as dramatic as last year, with the resulting “higher base” effects helping to bring headline EM inflation rates down this year.
- Developed market economies have more or less closed their output gaps — the difference between actual GDP (output), and potential GDP when at full capacity — via stimulatory fiscal policies enacted amid COVID-19. Most EMs, by contrast, have not had the same fiscal space to combat the crisis, allowing their economic outputs thus far to remain well below year-end 2019 levels. Given their still sizable output gaps, EM countries are more likely to experience growth without inflation running amok.
- As noted, most EM central banks have been very orthodox so far in their handling of monetary policy and have “front-run” developed market central banks, particularly the Fed, by hiking interest rates sooner rather than later. Therefore, we believe EM local debt markets may be poised to demonstrate resilience this year, even in the face of a potentially more hawkish Fed in 2022.
Final thoughts on EM local debt
While there are still many unknowns on the horizon for 2022, two things seem fairly certain from our perspective: 1) EM local assets are generally under-owned by global asset allocators; and 2) there appears to be a healthy amount of skepticism already priced into many of these assets. Accordingly, we believe now may be an opportune time for discerning investors to seek out attractive entry points into some EM local debt markets.
Expert
Related insights
Showing
of
Insights Posts
URL References
Related Insights
Stay up to date with the latest market insights and our point of view.
Read next
Showing
of
Insights Posts
How would emerging markets weather a “standard” recession?
Macro Strategist Gillian Edgeworth explores the potential impact of a developed market recession on emerging markets.
Quick Take
2024-08-31
EM equities: Can they prove the doubters wrong?
Multi-Asset Strategist Adam Berger offers six reasons that EM equity performance could be much more compelling in the decade ahead, from attractive valuations to economic tailwinds to mean reversion in the US dollar.
Article
2024-05-31
Emerging markets health care: Ready for takeoff?
Global Industry Analyst Sue Su shares her sanguine outlook on the health care sector in emerging markets, especially in China, which represents the largest opportunity in this space.
Quick Take
2024-03-31
India: Structural tailwinds for 2023 and beyond
Following his recent trip to India, Macro Strategist Tushar Poddar shares why he's very positive on the country's medium- to longer-term structural outlook.
Quick Take
2024-03-31
Why investing in themes for EM equities may reap rewards
Portfolio Manager Dáire Dunne outlines why he is increasingly optimistic about the potential opportunities within select EM equity themes this year.
Article
2024-02-29
Emerging local debt markets: Time to wade in?
Fixed Income Portfolio Manager Michael Henry sees positive trends across ELD fundamentals, valuations, and technicals that could be tailwinds for these markets going forward.
Continue reading
Article
2023-08-31
Six reasons India may be on the cusp of a major upcycle
Numerous positive structural and cyclical factors are pointing towards a major economic upcycle in India over the next five to six years, in our view, creating a range of potential investment opportunities. We believe India’s market is supported by an evolving investment universe, powerful demographic trends, increasing urbanisation and rising wealth, export growth, geopolitical tailwinds and a supportive policy regime. These factors are coalescing at a time when the corporate deleveraging cycle of the last few years is coming to an end and a new upcycle in profitability could be beginning.
Continue reading
Quick Take
2022-12-30
Navigating a new tomorrow
In this video, Wellington investment professionals and prominent guests articulate the structural risks and opportunities that we believe will shape tomorrow’s investment strategies, ranging from medical innovation spurred by the global pandemic to technological breakthroughs, and ideas aimed at curbing or mitigating climate risk.
Continue reading
Event replay
2023-01-31
URL References
Related Insights