Senior Portfolio Manager Anthony Kettle’s weekly BlueBay Emerging Market Debt commentary offers readers a concise yet wide-ranging macro overview. Kettle covers markets large and small, providing insight on how financial, political, and economic developments in one region affect markets elsewhere. Here is his latest insight.

Summary

Ongoing rotation in equity markets, coupled with heightened geopolitical risk this week, dampened risk sentiment. This resulted in the S&P 500 losing -0.4% and meagre returns of 0.5% for the Euro Stoxx 50, while emerging markets (EM) equities outperformed with robust gains of 2.2%. The US rates curve bear flattened with 5-year yields rising by 7 basis points (bps) and 30-year yields increasing by 2bps. 10-year US real rates rose by 2bps to end the week at 1.89%.

In EM credit markets, spreads were 7bps tighter for corporates and 4bps tighter for sovereigns, while total returns were up 0.2% and 0.1%, respectively. In the corporate space, the real estate and industrials sectors outperformed, while the diversified and banks sectors underperformed. In the sovereign space, the notable performers were Colombia, Gabon, and Zambia. The biggest underperformers were Senegal, Venezuela, and Ukraine.

In the EM local markets, returns were flat, with little differentiation in performance between foreign exchange (FX) and rates. In the FX space, outperformers were the Mexican peso, which gained 1.5%, the Uruguayan peso and Colombian peso, while underperformers were the Indian rupee, Polish zloty and Brazilian real. Meanwhile, in the rates space, Colombia was the best performer, followed by the Dominican Republic and Uruguay. Key underperformers were Mexico, the Czech Republic and Indonesia.

Market highlights

In Iran, the internet blackout, coupled with a brutal crackdown on protesters, appears to have reduced the number of protests against the regime. Regional states, including Saudi Arabia, Turkey, Qatar, Oman and Egypt, all attempted to de-escalate the situation and convince the US to abstain from military strikes on Iran. President Trump appeared to climb down from his earlier threats, as he claimed to have received certain assurances from Iran regarding its treatment of protesters.

Market outlook

Macro markets have been unsettled by both geopolitical concerns, as the US hardens its stance on Greenland, as well as on the economic front as the announcement of snap elections in Japan have caused a disorderly move higher in long-end yields in Japan. Equity markets have traded poorly in response to these events, although the extent of the sell-off has been reasonably mild. This is reflective of the market’s base case that the Greenland situation will ultimately be resolved through diplomacy, as an off-ramp is found given President Trump’s increasing political constraints ahead of the US mid-term elections in November. Meanwhile, the sell-off in Japanese yields has also impacted bond yields elsewhere, with Treasury and Bund yields both moving higher and curves steepening as markets remain concerned about fiscal expenditure in many geographies. Global security concerns continue to weigh on fiscal accounts as countries bolster their military capabilities in a direct response to increasing multi-polarity in the international security system.

The policy volatility in developed markets is boosting investor demand for emerging market assets, as EM is increasingly seen as a source of diversification amidst global uncertainty. EM local assets stand out as particularly attractive, given high levels of interest rates and, in many cases, greater levels of fiscal prudence than their developed market counterparts. With interest rates in EM still seen as being on a normalisation path, which should bolster growth and add to strength in the foreign exchange (FX) space, there is a positive cycle underway that is likely to fuel demand for the asset class. EM credit markets, meanwhile, will be impacted by similar themes to developed market credit, where spreads are seen as relatively tight but mitigated by low default rates. However, all-in yields still look reasonably attractive and perhaps present a more stable alternative to government markets, where fiscal concerns are leading to significant supply and increased volatility. In addition, geopolitical events in areas such as Venezuela and Iran have led to outsized positive moves in credits, such as Venezuela and Lebanon, as investors look ahead to potential debt workouts under more market-friendly regimes. In summary, we continue to expect EM fixed income to be a relative outperformer, as investors look to EM as a diversifier and a source of value in a rapidly changing world.