We speak with Wim Vandenhoeck and Gerald Evelyn about their views on emerging market local debt and why the current macro environment provides a supportive backdrop.
Wim: With global growth numbers looking extremely positive and inflation not a worry, we expect renewed inflows into emerging markets. This should result in flatter yield curves in countries likely to achieve fiscal consolidation in the next two to three years. While we expect an uptick in inflation in the next few months, due to base effects and commodity price pressures, in general, we believe large remaining output gaps will prevent most central banks from even starting to think about rate hikes.
Gerald: We believe interest rate and currency valuations are now more attractive than they were at the end of last year. The five-year portions of emerging market government yield curves are especially compelling, in our view, given their attractive carry and roll potential.
And we believe the opportunity on the currency side is potentially significant. Clients often ask about the possibility of US growth outperforming the rest of the world, versus current expectations. There is concern that this could result in a stronger US dollar. While the US may grow faster than the rest of the world, we believe the impact of better global growth outweighs the importance of the growth differential in determining the direction of the US dollar. We believe the key factor in this dynamic is the anchoring of front-end US interest rates; we are not worried about the impact of a long-end steepening of the US yield curve, as long as the front-end stays put.
Wim: We continue to believe that global macro conditions are setting the stage for a sustained outperformance of emerging market assets over the next three to five years. Growth, fueled by progress on global vaccinations, is likely to gain momentum in the coming years and the changing policy framework at the Fed, which implies a greater tolerance for inflation, should make it likely that US financial conditions remain favorable for this self-sustaining emerging market cycle.
Gerald: Most central banks remain on hold, and we saw what could be the last of the interest rate cuts in Indonesia and Mexico in this cycle, at least for now. The repricing of US interest rates has been a key driver of markets in recent months. Excitement about US growth (vaccines, plus fiscal stimulus) has caused investors to test the Fed on its average inflation targeting regime. The market priced in higher inflation and brought the hiking cycle forward.
Nevertheless, we believe the new Fed framework will hold, and Fed Chair Jerome Powell has confirmed this - he has maintained that a steeper US yield curve is acceptable, as long as front-end rates remain anchored. Given this policy stance, we believe recent market moves will not have a negative impact on the medium-term outlook for emerging markets. On the contrary, it confirms our view that there is a three to five-year cycle of good global growth on the horizon, which, combined with a lower US dollar, should be potentially rewarding for emerging market investors.
Wim: One country that has been relatively steady to start the year, and for good reason, is Egypt. Following the successful completion of a three-year International Monetary Fund program, the COVID-19 pandemic threatened to derail its economic recovery. Certain COVID-19-related sectors, like tourism, were especially hurt and weakness in its European trading partners damaged its exports. But despite these headwinds, interest rates and the currency have held steady. Because of its relatively diversified economy, commitment to fiscal reform and stable external funding support, Egypt has been resilient and we believe it is well-positioned to continue managing the current challenging conditions.
From the start of the year, Peru has been one of the few countries we have viewed negatively from both an interest rates and currency perspective.
We believe the unique character of locally denominated debt in emerging markets calls for a different look at risk management and manager skill.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Data as of 15 April 2021 unless stated otherwise.
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Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals, they are subject to change without notice and are not to be construed as investment advice.
