Talking Heads – US rate cuts would benefit frontier market bonds as well

This is an audio transcript of the Talking Heads podcast episode: US rate cuts would benefit frontier market bonds as well

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 emerging market frontier debt, the subset of emerging markets composed of sovereign bond issuers with less developed capital markets, also known as low-income or middle-income countries based on the level of GDP per capita. I’m Andy Craig, Co-head of the Investment Insight Centre, and I’m joined today by Guy Tossou, who is a Senior Portfolio Manager for Emerging Market Frontier Debt in our London office. Welcome, Guy, and thanks for joining me. 

Guy Tossou: Hello, Andy. Thank you for having me. 

AC: Perhaps to begin with, it would be good if you could give us a high-level overview of emerging market sovereign debt. And then talk about how the prospect of interest rate cuts in the US from the Federal Reserve have influenced asset prices in the emerging market sovereign debt market.  

GT: Emerging market fixed income debt is a quite robust and growing market. And when you look at the sovereign debt, it has been quite resilient over the last month with spread absorbing most, I would say, of upswing in the US Treasury yields through April. Since we continue seeing the spread on a narrowing trend and a medium-term trend to keep grinding tighter is likely, I can highlight here a few facts. First, we are seeing US rates moving lower The US economy is strong, but cooling, and for me this is the most important is the slightly better inflation prints. We expect policy rate cuts to begin only in the fourth quarter of 2024. We continue to see a soft-landing scenario in the US economy and that growth will remain above trend to 2025.  

AC: Let’s talk about frontier market countries now. They went through a difficult time during the pandemic. Some countries defaulted on their debt. And we’re talking here about countries like Nigeria, Egypt, Costa Rica, Jamaica, Benin. These are some of the countries that are part of this subset of emerging markets that are included in the frontier market countries. Now, they’re not all small countries. It’s not just because they’re small that they’re frontiers. It’s often because they have less developed capital markets, or they are low-income or middle-income countries. It’s quite surprising that they did well or have done relatively well since the pandemic. How do you assess the current situation and what do you think prospects are for the rest of the year and for the future? 

GT: During the pandemic, most of the countries face liquidity crises and the multilateral development banks emerged as the lender of last resort. The World Bank, for instance, stepped up its crisis facilities. IMF lending has also increased to record high level. Mitigating some of the immediate concern about liquidity and the official creditor guarantee has been effective as well. We can say today that with confidence the multilateral system showed its value. The primary market reopened for the lower-rated sovereign. Of course, strong policymakers have made and implemented necessary reforms. Investor confidence is again positive.  

AC: If we look at the performance of these  high-yielding emerging market sovereign bond issuers, they’ve really had a period of very strong performance since about October last year. And we see that in the fall of the risk premium for the benchmark emerging market global diversified bond index, the fall means that the yield on this index perhaps now looks a bit less attractive. Do you agree with that? 

GT: Bonds have performed well, as you said, and they have had a stunning rally that has started late October last year. But We had this year some episodes of performance retracement. , This volatility creates opportunities. We have long argued that riskier sovereign bonds were undervalued relative to other segments, particularly when you compare this to the investment-grade buckets. This huge gap has almost closed. Pakistan has recovered more than 75% of the losses, Argentina at about 60%, 50% for Egypt and for Ecuador, it’s 45% about. When you look at Ecuador, Ukraine, Zambia and Sri Lanka, successful IMF programme reviews also worked well. Most continue today to benefit from the progress with the IMF programmes and policy adjustment.  

AC: As I understand it, frontier markets make up about 20% of the bonds in the emerging market global diversified bond index in terms of positioning. Where do you currently see value? Which are the sectors, the subsectors within that index, which you favour at the moment and think offer value to investors? 

GT: As we already discussed, spreads are now trading tight relative to historical averages, and this is the reason why we are neutral over all emerging markets credits in our asset allocation. However, within the asset class, we are still overweight specific names in the high-yield universe, including some frontier markets where we continue to see value. But we believe there is still room for spread compression supported by the prospect of the US rate cut, coupled with improving fundamentals in some frontier countries where we see solid macroeconomic prospects. Within the frontier markets, we are now shifting to local markets where we see the bulk of the value as policymakers have taken necessary action for macroeconomic stability on the one hand and also to diversify the economy. Another quite important step: the macro economy benefited from foreign exchange, which has been liberalised in some countries. And this will help get [them] more capital flows. We continue to be positive on our asset class.  

AC: Guy, thank you for joining us today.  

GT: Pleasure to be with you.