At their current levels, local rates provide a good cushion

Emerging Market debt denominated in local currency is one of the most attractive Fixed Income asset classes, with a yield currently at around 7% (Chart 4).

Current yield levels provide a cushion against further local currency correction and core rate volatility. Many Emerging countries are facing lower inflation due to lower commodity prices or weak domestic demand. As a result, we expect new rate cuts, especially in Asian countries such as India and Indonesia. In the same way, many Eastern Europe countries are adopting a more accommodative stance to boost inflation prospects. This could generate support for local rates. With this in mind, we maintain a positive bias on the Hungarian debt. Rating upgrades by one of the rating agencies are also likely for the country. Elsewhere, we continue to remain exposed to countries like India and Russia. The former is showing a declining CPI, an attractive carry relative to its peers combined with an improving macro environment and a will to pursue the implementation of structural reforms. Russia is also showing a high carry, and we expect rate cuts and, finally, disinflation. We also overweight Mexico which is now on a growth recovery mode with improving fundamentals.

However, we remain cautious on many local Asian rates. Asian economies are linked to China (Thailand), display low carry (Thailand, Malaysia) or are facing political risks (Malaysia).

External EM debt is attractive in a long-term perspective

In a global fixed income context, external debt is displaying attractive features, with a spread versus US Treasuries fluctuating at around 400 bps. In a low-yield environment, we consider this spike in the spread as a good buying opportunity given the attractive risk/return features. Technical factors will continue to be supportive as net new supply (gross issuance minus redemptions and coupons) is close to zero. On a one year horizon, we expect positive asset class return of around 4.7% on an assumption of 90 bps US Treasury yields widening and 40 bps EM spread over Treasury tightening.

We favour some Central European countries such as Hungary Croatia and Georgia, all commodity importers. We also like Pakistan, a country in a recovery path with attractive return perspectives. We dislike Lebanon which displays expensive valuation features considering the current economic and political contexts.

We favour some Central European countries such as Hungary and Slovenia, both commodity importers with medium-term upgrade momentum.