Emerging market debt – both sovereign and corporate – should benefit as the dollar’s relentless advance of the past 15 years starts to run out of steam.
Aligning stars
The stars are aligning for emerging market (EM) debt. And according to our analysis, there are good reasons to believe these assets – both sovereign and corporate bonds – are on the cusp of an upswing that could last for years to come.
To begin with, there’s a shift in the direction of the US dollar. The signs are that the currency’s relentless advance of the past decade is starting to run out of steam. US exceptionalism is being called into question: investors’ appetite for risk is steadily returning following the Covid pandemic, the initial shock caused by the Ukraine war and years of disinflation and distortive monetary policy.
And with the dollar playing a smaller role, other factors are likely to take over in driving EM fixed income.
One boost is likely to come from China’s dramatic volte-face on its Covid policy, dropping draconian lockdowns for complete reopening of its economy.
Then there’s EM economies’ deft handling of inflation. EM central banks acted early and decisively to contain inflationary pressures, leaving developing economies well placed to significantly outgrow their developed counterparts.
Together, these factors are bound up in what is arguably the most important source of EM fixed income performance: foreign exchange.
For EM fixed income, currency movements are consequential – not only for bonds issued in local currencies but also for those denominated in US dollars. Currency movements can create feedback effects that have a major bearing on a country’s overall finances. Similarly, they can have a critical role to play in EM corporate balance sheets.
For investors, this can result in substantial compounding effects – appreciating local currencies generate virtuous cycles that feed through to fixed income returns. This is apparent in the relationship between the dollar’s relative value and how global asset markets perform – a weaker dollar tend to be associated with relative strength in non-US assets and a strong dollar with stronger US assets.
Opinion written by Mary-Therese Barton, Head of Emerging Market Fixed Income of Pictet Asset Management, and Alain Nsiona Defise, Head of Emerging Markets – Corporate of Pictet Asset Management.
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