Emerging Market Debt Indicator January 2024

Our EM Debt team provides an update across the investment universe and shares the latest outlook and current top-down positioning.

Feb 9, 2024

14 minutes

EMD Team

Chapters

01
Market background
02
Top-down views and outlook
03
Africa
04
Asia
05
Latin America
06
Central and Eastern Europe, Middle East and South Africa
07
EM corporate highlights
01

Market background

Close-up of dark green leaves
Indications from the US Federal Reserve that interest-rate cuts will only happen later in the year weighed on fixed income markets. US economic data remained robust, and the US dollar strengthened against emerging market currencies.

Initial optimism around looser US monetary policy was tempered at the end of January, when the US Federal Reserve (Fed) updated the market. Recognising that market expectations were running ahead of the central bank, Fed Chair Jerome Powell made it clear that a rate cut was unlikely in March. US GDP and jobs data remained strong, further feeding the narrative of a soft landing for the US economy. On the geopolitical front, tensions remained high following an attack on a US air base in Jordan, while Houthi rebel attacks on commercial shipping in the Red Sea continued to disrupt supply chains, which prompted joint military responses from the US and UK governments.

Within emerging markets (EMs), inflation continued to fall and come in lower than expectations in Central and Eastern Europe, while growth data remained soft. In Latin America, central banks in Chile, Colombia and Brazil cut their respective interest rates, with the trend of falling inflation continuing. In China, Q4 GDP was weaker than expected, and the People’s Bank of China (PBoC) announced a 50bps cut to the reserve requirement ratio.

Turning to EM debt market performance, the local currency bond index (JP Morgan GBI-EM) fell 1.5%, driven by currencies, which came under pressure from the stronger US dollar. In the hard currency debt market, the sovereign index (JP Morgan EMBI) returned -1.0%, while the EM corporate debt market (JP Morgan CEMBI) gained 0.6%.

02

Top-down views and outlook

Sea with shore
From a top-down risk perspective, we reduced our target to a smaller overweight. We retain an overweight target for EM hard currency debt, and are now running a modest overweight in EM currencies. In the EM local currency space, we reduced exposure slightly but remain overweight.

Top-down positioning at the end of January 2024

- - - 0 + ++
Overall risk
Hard currency debt
Local rates
FX

For illustrative purposes only. For further information on the investment process, please see the important information section.

From a top-down risk perspective, we have reduced our target to a smaller overweight, as although the global environment remains positive for risk assets, there is a risk that inflation in EM economies becomes more volatile. We have kept our overweight target for EM hard currency debt, as we believe we are past the peak in US yields and that should be supportive for EM external (hard currency) assets. In the EM local currency space, we reduced exposure slightly. The overall direction of travel for core rates should give confidence to some previously cautious EM central banks, but the inflation outlook is more uncertain. We are now running a modest overweight in EM currencies, acknowledging strong underlying country fundamentals, high carry and healthy external balances.

Outlook

The global inflation picture continues to be one of moderation overall. Recent data releases have led markets to become more confident of a soft landing (rather than a recession) for economies, especially the US. While financial markets are likely to remain volatile, we continue to be constructive on the medium-term outlook for returns from the EM debt asset class.

Many EM economies have solid fundamental foundations. The more fragile economies are receiving plenty of support from the IMF and other multilaterals. Furthermore, with much of the painful interest-rate hiking now behind them, most EM economies are in an enviable position relative to developed markets overall, with most EM central banks either having completed their hiking cycle or beginning to cut rates. EM bond market valuations look attractive – with some markets still pricing in significantly more risk than we believe is justified.

Following the strong December rally in US Treasuries, the market has been reassessing when the US Federal Reserve is likely to begin cutting interest rates and expectations of a March cut have receded. This was compounded by Jerome Powell’s more hawkish comments at the end of January and the subsequent strong US non-farm payroll number. However, risks remain that the Fed does not unwind its tight monetary policy as quickly as the market is currently pricing in, which may lead to rate-market volatility.

03

Africa

Africa
Ghana reached a deal with the official creditor committee, paving the way for an IMF disbursement. Côte d'Ivoire issued new debt in the primary market; healthy demand for this suggests brighter times lie ahead for other high-yield rated African nations seeking to access primary markets.

The prospect and timing of a potential IMF programme for Egypt continued to dominate discussions in the market, with some suggesting the eventual deal could be in excess of US$7 billion. Our base case view is that the IMF deal will be agreed upon as the central bank hiked rates by 200bps; fiscal consolidation measures announced have been in line with the IMF’s expectations; and there has been continued progress on privatisation of state-owned enterprises. All of these are prerequisites for an IMF deal. An IMF deal would also involve further devaluation of the exchange rate, which was under pressure over January, with local corporates selling the Egyptian pound in the parallel market for c.50% less than the official rate. Egypt was also officially removed from the JP Morgan GBI-EM local bond index due to the currency market being dysfunctional.

The currency in Nigeria also experienced a significant devaluation over January, as the central bank changed its methodology in the official published daily currency fixings. We have also seen various measures from the central bank to improve the transmission mechanism of its monetary policy and help align the official policy rate with rates currently seen in the market. Despite these measures, the central bank ultimately needs to raise its policy rates to help relieve the FX pressures.

The government in Ghana reached a deal with the official creditor committee, which paves the way for an IMF disbursement and for bondholder negotiations to resume. Inflation fell dramatically in December, and the central bank cut rates by 100bps in January.

Despite Zambia’s budget deficit being smaller than expected, the kwacha came under more pressure in January, with the country’s copper production falling significantly. The weaker currency is also feeding through to higher inflation. Regarding the ongoing debt restructuring delays, the ball remains in the court of China and the IMF, with little progress made over the month.

The central bank in Tunisia is moving forward with legislation that will allow the government to borrow directly from the central bank. Although this is not approved yet, it raises fiscal discipline concerns and makes a potential IMF deal more unlikely.

Kenya received an IMF disbursement in January. The government is considering plans for its June 2024 debt maturity; this may be funded from a new issue or a partial bond buyback, but is yet to be confirmed.

Côte d'Ivoire issued new debt in the primary market and this was met with healthy demand by investors. This will help lead the way for other high-yield rated African nations to access the primary markets after a two-year gap, with Benin now looking to issue debt in US dollars.

04

Asia

Asia
Investor sentiment towards China remained weak, and a more fragile growth backdrop prompted a 50bps cut in the reserve requirement ratio by the People’s Bank of China, and other measures to loosen financial conditions in certain industries. India’s economic activity remained strong.

Investor sentiment towards China remained weak over the start of 2024, weighing on domestic equity markets. On the economic data front, credit data and retail sales were both soft, reflecting weak domestic demand, while the Caixin services PMI fell slightly from December but remained in expansionary territory (above 50). The NBS manufacturing PMI was in line with expectations but below 50. GDP growth for 2023 was also slightly below expectations, at 5.2% versus 5.3%, but above the official target of 5%.

Given the weaker growth backdrop, the PBoC surprised the market with a reserve requirement ratio cut of 50bps, which is expected to free up a further CNY1 trillion (c.US$140bn) in liquidity. There was also a further loosening of financing for select industries, including measures to help property developers. The market was expecting a cut to the medium-term lending facility, but this did not materialise. Deflation continued but was not as weak as expected, with the December CPI figure of -0.3% versus -0.4% expected year-on-year. Core inflation remained stable at 0.6%.

In India, economic activity continued to be strong, with the services PMI climbing higher over January, while the manufacturing PMI rose to a four-month high. On inflation, the December consumer price index was lower than expected at 5.7% versus 5.9%. Core inflation also fell to under 4% for the first time since March 2020.

The Bank of Korea kept rates on hold in January as expected, however, the messaging turned from a hawkish tone to a more neutral stance. Five out of six members now believe that rates have peaked (from two out of six at the last meeting), although it is still too early to consider rate cuts. Trade data continued to be supportive for the won, given a combination of strong exports from semiconductors and weaker imports.

The Monetary Authority of Singapore (MAS) also kept rates unchanged in January and continued to push back against calls for looser monetary policy. Core inflation figures were higher than expected, at 3.3% versus 3.1%, while MAS lowered its 2024 headline inflation forecast to 2.5-3.5% from 3-4%. The core inflation forecast has remained unchanged at 2.5-3.5%.

In Taiwan, the incumbent Democratic Progressive Party (DPP) won the presidential election as expected. However, the party lost its majority in parliament. The trade balance continued to strengthen, driven by tech exports to the US, however, December’s export orders and industrial production were disappointing.

Tourism arrivals in Thailand increased in December compared to much of 2023, however, they remain around 20% lower than 2019 (pre-COVID) numbers. Inflation remained negative in year-on-year terms, with headline inflation at -1.1% in January, consequently weighing on the Thai baht. The fiscal policy office has reduced its 2024 economic growth forecast to 2.8% from 3.2%. There was also some pressure from the prime minister on the central bank to cut rates, however, the Bank of Thailand has pushed back on this.

05

Latin America

Latin America
Inflation continued to fall across the region, printing lower than expected in many cases and allowing central banks to continue or accelerate rate-cutting activity. Argentina reached an agreement with the IMF, which will unlock US$4.7 billion of funding.

Inflation continued to fall across the region, with much of this coming in lower than market expectations. This allowed central banks to continue on their path of interest rate cuts, and even accelerate the pace of cuts in some cases. The one exception is Mexico, where the central bank has continued to push back on starting its cutting cycle, and it is likely to start reducing rates in March at the earliest.

In Argentina, the government and the IMF reached an agreement which will unlock US$4.7 billion of funding. At the same time, the new Milei administration has been struggling to get support from the lower house for its omnibus bill. This includes significant privatisation and tax measures, but in order to pass the bill, the government has removed all fiscal adjustment measures. However, the government remains committed to a balanced budget going forward.

Inflation in Brazil continued to be below market expectations, which allowed the central bank to cut the key policy rate by 50bps at the end of January. The bank said it will keep cutting by 50bps over the next several meetings. In economic data, industrial production was better than expected, while domestic demand remained resilient. However, the fiscal deficit was worse than expected in December, driven by the settlement of court-ordered payments. President Lula caused concern among investors with the announcement of a new industrial policy plan; it has since been confirmed that the plan will create no new fiscal cost, allaying some of the market’s fears.

Chile came to market with new debt issuance of US$1.5 billion, with the government signalling that this concludes Chile’s hard currency debt issuance for the year, with the remaining financing needs to be met by the local debt market. There was also a downside surprise in inflation, which was 3.9% year-on-year versus 4.5% expected. At the end of January, the central bank accelerated its pace of cuts from 75bps to 100bps, with one central bank member voting for a cut of 125bps. In the currency market, the ministry of finance continued to sell US dollars into the secondary market, but this did little to support the peso.

There was weak economic data in Mexico, albeit from a strong base, with Q4 GDP growth decelerating, and industrial production and retail sales deteriorating. Headline inflation was higher than expected, which weighed on the local bond market, while core inflation was in line with the market’s estimates. In political news, President AMLO has been trying to implement two new reforms before he leaves office later this year. This includes linking the minimum wage to past inflation and linking state pensions to wage growth, both of which would have a fiscal cost. Although these reforms are unlikely to be passed, they increase the risks for the fiscal outlook.

The central bank in Peru cut its interest rates again by 25bps to 6.5%, and it expects inflation risks to fall in coming months, which could prompt it to accelerate its rate cuts. Economic activity continues to be better than expected, as does economic growth.

Inflation has continued to move in the right direction in Colombia, with the December figures coming in below expectations. Lower inflation expectations prompted the central bank to cut rates by 25bps, with some members voting for a 50bp cut. This all helped local bond yields to fall in January. Separately, S&P moved Colombia’s outlook to negative, which came as a surprise to the market.

In Ecuador, there were positive signals from the government as it is trying to pass fiscal measures such as raising VAT to 15% and cutting fuel subsidies. These adjustments would bring the country closer to an IMF deal.

06

Central and Eastern Europe, Middle East and South Africa

Central and Eastern Europe | Rest of Europe, Middle East and Africa
Growth data remained soft in the region and inflation continued to be lower than expected. In Turkey, inflation momentum slowed in Q4, but the government’s recently agreed minimum wage hike caused a significant increase in monthly inflation. The geopolitical backdrop in the Middle East remained fragile.

Overall, growth data continues to be soft in Central and Eastern Europe (CEE). Hard data such as industrial production and retail sales remain weak, and the latest purchasing manager indices (PMIs) continue to paint a fragile picture. A recovery in real incomes is underway, while a step up in EU disbursements and fiscal spending in some markets may start to support the growth picture in coming months. Inflation figures continue to surprise to the downside in Poland, Hungary and the Czech Republic. January may see some seasonal increases in inflation given wage rises, and further ahead there may be some potential for an upside surprise in Polish inflation as anti-inflation policies roll off over 2024 (such as VAT and fuel prices normalising). This has kept the National Bank of Poland as the most hawkish in the region, despite being the first to cut rates before the October 2023 election. Messaging from the Czech Republic central bank has suggested that while there will be rate cuts in subsequent meetings, there is a lack of consensus on the size of the cuts. In contrast, the Hungarian central bank remains the most dovish in terms of its general messaging, although it surprised the market by sticking to its 75bp cut in January, despite signalling that 100bps was on the table.

Hungary’s dispute with the EU led to some noisy headlines over January, but a deal was reached in early February. This will reduce the risks of EU funding being withheld, but more likely needs to be done to unlock the remaining frozen funds. In Poland, it has also been a noisy period for political headlines, although the risks of an early election appear to have receded as the president reluctantly signed the budget.

Turning to the rest of the region, in Turkey inflation momentum moderated materially in Q4, but the government’s recently agreed higher-than-expected minimum wage hike of 49% helped drive a significant increase in monthly inflation. The central bank governor resigned in early February. This was due to personal reasons and her replacement is a credible and orthodox policymaker. The challenging inflation profile may well require further policy action following the January hike to 45% and additional macroprudential tightening. Economic activity has been relatively soft in Turkey, with weaker industrial production and the PMI remaining below 50.

In South Africa, inflation was slightly softer than expected, and the central bank voted unanimously to keep rates unchanged, while reiterating its view that the current policy rate is in restrictive territory. Growth data remains mixed overall, with weak PMIs and disappointing manufacturing and retail sales data. As we enter an election year, former president, Jacob Zuma, has launched a new party, which could complicate the ANC’s ability to garner a majority.

In Israel, military operations continued in Gaza. In mid-January, the Israeli government approved a 2024 budget amendment, which could lead to an increase in the budget deficit target to 6% of GDP. This is a 4% slippage from the first budget draft. The wider geopolitical backdrop in the Middle East remains fragile, given Western airstrikes in Yemen and US casualties in Jordan leading to retaliatory strikes.

07

EM corporate highlights

Close-up of metal architecture
EM corporate debt markets performed well, thanks to a combination of credit-spread compression and healthy ‘carry’. Spreads tightened in the high-yield market but widened slightly in the investment-grade segment, which also came under pressure from higher levels of bond supply/issuance.

EM corporate debt markets performed well over the month, with returns primarily driven by spread compression and carry. The JP Morgan CEMBI BD returned +0.6% over January, with this being driven by high-yield issuers (+1.4%) as investment-grade (IG) issuers were broadly flat (+0.1%). As a high beta asset class, high-yield debt benefitted from some spread tightening as strong economic data boosted hopes that the Fed would be able to engineer a soft landing. In contrast, spreads among IG issuers widened slightly over the month, with the market also coming under pressure from higher levels of bond issuance.

Authored by

EMD Team

Important Information

This communication is provided for general information only should not be construed as advice.

All the information in is believed to be reliable but may be inaccurate or incomplete. The views are those of the contributor at the time of publication and do not necessary reflect those of Ninety One.

Any opinions stated are honestly held but are not guaranteed and should not be relied upon.

All rights reserved. Issued by Ninety One.

Investment Process
Any description or information regarding investment process is provided for illustrative purposes only, may not be fully indicative of any present or future investments and may be changed at the discretion of the manager without notice. References to specific investments, strategies or investment vehicles are for illustrative purposes only and should not be relied upon as a recommendation to purchase or sell such investments or to engage in any particular Strategy. Portfolio data is expected to change and there is no assurance that the actual portfolio will remain as described herein. There is no assurance that the investments presented will be available in the future at the levels presented, with the same characteristics or be available at all. Past performance is no guarantee of future results and has no bearing upon the ability of Manager to construct the illustrative portfolio and implement its investment strategy or investment objective.