24 NOV

2017

Fixed Income , Topics

We took some profits last month

EMERGING MARKET DEBT STRATEGY

We took some profits last month

External risks to EM rose again over the past month as concerns around monetary-policy normalization, Fed Chair appointment, growth-supportive tax reforms, and NAFTA re-negotiations in the US resurfaced. The US Fed hiked the policy rate in March and June in line with expectations and communicated a gradual unwind of the Fed's balance sheet in September, repricing expectations of a December hike and pushing US Treasuries towards the 2.30-2.40% area again. Chinese authorities are intent on maintaining growth around the 6.5% mark as they balance financial-system deleveraging with reforms and stimulative polices. The EM growth recovery is now more broad-based and likely to extend due to the rebound in global trade, stronger commodities and stable Chinese demand but has been offset by concerns over the impact of US policy on EMs. On balance, our top-down assessment has, therefore, turned more neutral. EM spreads have, so far, not corrected extensively in the face of the rise of these external risks but only widened by 15 bps on idiosyncratic EM stories like the potential Venezuela default and the surge in political uncertainty in the Middle East. As a result, we have turned more cautious on the asset class.

However, we do retain an overweight in Hard Currency Debt, being constructive on commodity exporters as EM credits have decorrelated from the tepid oil-price evolution (Angola, Azerbaijan, Ecuador, Kazakhstan) and specific idiosyncratic re-rating stories like Argentina, Ukraine, Egypt and Ghana. We also have a tactical and positive view on Venezuela given that bonds are now trading well below recovery values.

Our underweights include US treasury-sensitive credits with tight valuations such as Panama, Peru, Chile, Uruguay, the Philippines and Poland. We are also underweight South Africa, which is suffering from tight valuations, domestic political transition risks, downgrade risks, insufficient fiscal adjustment and weak growth.

We reduced our exposure in October, but select local rate markets remain attractive

Local Rates continue to benefit from limited EM inflation pressures or outright disinflation in some markets and accommodative EM central bank policies although we are towards the end of the EM easing cycles or these have been fully priced-in in most markets. The EM cyclical growth recovery is expected to continue as most EMs are still at below-potential growth. We remain constructive on select EM Local Rates markets but have scaled back our position overall.

We continue to see value in EM Local Rates and remain overweight select high-yielders that are supported by high real rates and constructive disinflation dynamics (Brazil, Colombia, Russia), though we have reduced the overweights and are looking to re-enter at better levels.

We are underweight lower-yielding local rates markets in Asia and CEE such as Thailand (expected underperformance of low-yielders) and the Czech Republic (continued tightening by the CNB). Finally, we hold an underweight position in Turkey on the back of rising domestic political and US Treasury risks, unbalanced growth and elevated inflation.