Talking Heads - Emerging market debt: Further to go after a strong run

This is an audio transcript of the Talking Heads podcast episode Emerging market debt: Further to go after a strong run

Andrew Craig: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing the performance of emerging market debt so far this year and the outlook for the rest of the year. I’m Andy Craig, Co-head of the Investment Insights Centre. I’m joined today by Alaa Bushehri, who is Head of our Emerging Market Debt team in London. Hello, welcome and thanks for joining me.

Alaa Bushehri: Hello, Andy.

AC: Could you talk us through what’s driven performance in emerging market debt through to the end of August and with what have been the main factors that have been influencing performance?

AB: Sure. Emerging market debt has experienced has had  a good performance year to date. And the driving force behind this is really twofold. And when we look at the asset class, it is important to divide it into the core and non-core parts of the universe. Now the core parts I would describe as big benchmark names [that] are liquid and a staple in emerging markets and they have really benefited from a risk-on environment this year with an easing cycle expected to be rolled out in developed markets, but [that] has already materialised in emerging markets.

The other parts of the universe that we would look at is the non-core parts and that’s the high-yielding idiosyncratic names across emerging markets. And what we have seen there is a strong performance year-to-date. The driving force behind that over the last 18 months to two years, we’ve had these issuers really work on optimising their balance sheets and negotiating with all stakeholders, multilateral, bi-lateral, investors such as ourselves to address their financing needs. And we have seen that materialise across different countries and that has significantly contributed to performance.

AC: So, as you say, there’s been a certain putting houses in order among these idiosyncratic names. How do you see things playing out through to the end of the year? As you say, we seem to be on the brink of a cycle of rate cuts in developed markets. Presumably, that has positive consequences for emerging market debt.

AB: Yes, absolutely. The easing cycle across different EM countries has already started. And what we are waiting for now is for developed markets to follow. And the US is one that everyone is waiting for. That is going to be key to see what the rest of the year is going to look like in terms of rate decisions.

Now what is important is how much and how fast that happens and why that is important is because market can digest so much. We are looking at a contained measure in terms of what the US Federal Reserve  delivers and could be digestible by markets. What we are really looking out for are the extreme probabilities of, for example, no cut at all this year or much more than what market is expecting and can digest. That could contribute to volatility from here.

As you say, the known unknown is what pace and to what extent the Federal Reserve will cut policy rates through to the end of the year. At the moment, there still seems to be a consensus for a soft landing. But as you pointed out, if there are extreme events and that soft landing does not materialise, then that would obviously change the outlook.

AC: Apart from the Fed, what are other factors do you see as important for emerging market debt? So, are there any other issues that you see as potentially important for investors to keep an eye on?

AB: Well, the US elections is one that everyone is following. And what I would say that while that is important, we would highlight that both candidates that are running are more on the predictable side in terms of expectations of what their policies are.

Away from that, what we are focusing on are elections in emerging markets. We’ve already had elections in South Africa and in Mexico. And the policy roll-out there is what is important with the new governments in place, even if they are from the same party or from predominantly the same party. We have other elections coming up in emerging markets. The domestic moves there in policy are important moving forward. The direction of those policies could affect these economies at different levels, whether it’s on the spending front or on fiscal policies. And in emerging markets, another element that’s we continue to follow are geopolitics. The war in Ukraine continues, as does the one in the Middle East. And although it’s unpredictable, we do watch it closely to assess how that affects different economies and supply chains across emerging markets.

AC: When we take all those factors into account, why do you think investors should look closely at emerging market debt as a potential investment at the moment?  And perhaps you could distinguish between hard currency emerging market debt and local currency debt.

AB: What I would focus on here is when we look at emerging markets, it’s important to highlight that the fundamentals continue to go from strength to strength. When looking at the different economies and the different fiscal balances, there has been a multi-year, multi-decade focus on improving those across the board and that has been reflected in [credit} spreads across the different jurisdictions. When looking at those fundamentals and comparing them to peers in developed markets, we see that EM continues to provide a pick-up over DM peers when you’re looking at the same rating buckets. That continues to be the case and one we think investors should take advantage of.

On local currency, our expectation is that the easing cycle is to continue for the rest of this year and into next year for most EM economies. If we look at it by region, in LATAM [Latin America}, it’s expected to remain the regional driver of lower of lower policy rates and we expect countries like Colombia, Chile and Peru to deliver on this. In emerging Europe, we’ve already seen several countries lead the easing cycle as we have in emerging Asia as well. Now, when you look at historical figures, the periods around the first cuts of a cycle by the Fed is not always bullish for EM assets, in part because the macro environment surrounding the initial cut is typically associated with slowing growth and risk aversion. But our conviction is focused on the consistent gains that are to be found in EM rates. So, EM local bond yields have consistently moved lower around the first Fed cuts of each cycle, driving performance of EM local rates into the end of this year and next year.

AC: Thank you very much for joining me today.
AB: Thank you very much for having me.