Local rates are resilient

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).

Many Emerging countries are facing lower inflation due to lower commodity prices or weak domestic demand. As a result, Emerging central banks are adopting a more accommodative stance by cutting policy rates. This could generate support for local rates. In particular, 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 environement 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.

However, we remain cautious on local rates from commodity exporters like Peru, Colombia, Malaysia and countries whose central banks are in rate-hiking mood (South Africa, Brazil). We are underweighting local Brazilian bonds: inflation is getting higher and higher. In these conditions, the Brazilian Central Bank is restricted to cutting its rates. We consider that the interest rate rise could continue in this environment.

Appealing risk/return features of external debt in an illiquid 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. However, we display some cautiousness as the environment was shown signs of illiquidity. Technical factors are thus less supportive although the low net new supply remains low (Chart 5).

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