The US Federal Reserve (Fed) has recently cut interest rates, and further cuts are expected, which will be supportive for fixed income market returns. If the Fed is able to engineer a soft landing for the US economy – a scenario that is becoming widely accepted as the base case – this would create a supportive environment for risk assets, including emerging market (EM) corporate debt.
More broadly, the shift to a rate-cutting regime in the US opens the way for more monetary policy easing in general across emerging markets (as is already evident by China’s significant policy easing announcements in the wake of the Fed’s September rate cut). This should provide a tailwind for EM economies that is supportive for the EM corporate debt asset class.
At the macro level, across EM economies, we are seeing increasingly healthy primary fiscal balances, and external resilience is improving post-COVID on stronger basic balances (current account + FDI). In addition, the structural economic growth premium of EM relative to developed markets (DMs) remains intact and above its long-term average. All of this points to EM economies being in a good position structurally. At the micro level, EM corporate fundamentals remain healthy, and as such we expect default rates to continue to trend down.
Valuations in EM credit currently look attractive, both on an absolute basis and relative to other asset classes. Yields in the asset class have not been seen at these levels since the aftermath of the GFC, and this paints a positive picture for the returns outlook. In instances where the yield of the JP Morgan CEMBI has been above 5.5% (at the time of writing it is around 6.0%), returns over the subsequent 12 months have been over 10% almost half of the time1.
Past performance does not predict future returns; losses may be made.
On a relative basis, EM credit continues to offer a spread pickup compared to DMs, and while the pickup vs DM isn’t as large as it has been, that structural premium still exists. This is despite the fact that on average EM companies operate with lower levels of leverage than their DM peers.
Looking at market technical (supply/demand dynamics), we expect the tailwind of lower issuance rates to continue to support the asset class. We have seen this dynamic play out this year, as although issuance has picked up in EM corporate markets, it is still subdued in comparison to DM and the US investment-grade market in particular which has continued to see high levels of supply.
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1 Calculations based on data between June 2009 and June 2024.
General risks. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses leading to large changes in value and potentially large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Liquidity: There may be insufficient buyers or sellers of particular investments giving rise to delays in trading and being able to make settlements, and/or large fluctuations in value. This may lead to larger financial losses than might be anticipated. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.