Emerging market bonds stand to benefit from a range of factors: we expect economic growth to remain resilient into 2025, supported by robust private consumption, healthy investment and buoyant exports. Meanwhile, inflation has largely fallen to normal levels in many countries, which should allow for further monetary policy easing.
Performance of hard currency (that is denominated in US dollars) bonds issued by sovereign and quasi-sovereign emerging market (EM) entities has been attractive this year. The JP Morgan EMBI Global Diversified Index returned 8.64% for the year through September.
Money continues to flow into EM hard currency bonds, local currency denominated bonds and corporate bonds, while the supply of these bonds remains below pre-pandemic levels.
Volatility may persist because of the US elections, commodity prices responding to geopolitical concerns, and uncertainty over the pace of economic growth in China. We do not, however, expect any of these factors to derail the EM economies or bond markets.
In the meantime, the current combination of positive fundamental and technical factors support staying invested in EM bonds, enjoying the relatively higher yields they can offer.
Local currency bonds – A compelling opportunity
History shows that EM local currency bond yields are more likely to follow the Fed, with yields falling and prices rising. Inflation-adjusted yields are now at historically attractive levels, particularly relative to real yields in the US.
Renewed economic growth, stable inflation, lower interest rates and attractive valuations suggest the asset class could provide compelling returns over both the short and medium term.
Country selection matters as some regions or individual countries are further along in their monetary easing cycle than others and some have yet to start.
We expect Latin America to remain ahead in lowering rates, led by Colombia, Chile and Peru. In eastern Europe, policymakers in Hungary, Czechia and Romania are likely to be among the most aggressive in cutting rates, while economies in, for example, Turkey and Egypt, have only recently achieved the kind of stability that could allow interest rates to be lowered in the quarters ahead.
EM corporate bonds have attractive yields
EM investment-grade corporate bonds currently offer yields more than 1.5% higher than their developed market equivalents, while sub-investment grade (high-yield) EM corporates offer yields closer to 2.0% above their developed market equivalents.
EM corporate fundamentals remain robust, with recent earnings reports generally supporting a resilient outlook. While geopolitical tensions could disrupt supply chains, EM corporates have proven agile in shifting providers or optimising their cost structure to minimise the impact.
Finally, the supply of corporate bonds remains much lower than before the pandemic and we expect this more moderate level of bond supply at least through the end of 2024.
Be selective in hard-currency sovereign bonds
We are positive on EM hard-currency sovereign bonds, but performance is likely to remain somewhat diverse, with selected pockets having greater potential to generate outperformance.
For example, situations such as debt restructuring in Ukraine or Sri Lanka and developments in frontier markets such as Egypt and other African sovereigns could benefit from more pronounced economic growth and sustained demand for higher yields.
Beijing has recently stepped up its attempts to revitalise China’s economy. While it is too early to estimate how successful these measures will be or predict how much more stimulus it will ultimately provide, success would significantly improve the outlook for regional EM economies.
However, China’s challenges are enormous. We expect growth to continue to slow into 2025 as property market woes weigh on economic activity. But if we are wrong, and current or new stimulus measures raise growth sooner than we expect, China could support global emerging market bonds.
While caution ahead of significant events such as the US elections is warranted, we believe that investors are better served by focusing on the fundamental factors that drive markets over the long term. For EM sovereign and corporate bonds, those factors remain positive, while current yields offer compelling compensation for the uncertainties.
