Rally on external EM debt but risks have subsided

The main risks to the EMB asset class – China hard landing and policy mismanagement, commodities and hawkish US Fed monetary policy – have subsided. However, valuations are still attractive, as the elevated market volatility has created opportunities in oversold credits. Furthermore, asset class technicals are less supportive, since the net issuance is now expected to be positive but issuance is manageable and investors are not over-extended.

Consequently, we are keeping our overweight on Eastern Europe via Croatia (thanks to positive political & macro momentum), Montenegro, Serbia and Romania. We also maintained a modest overweight exposure to the energy complex such as Venezuela, Ecuador and Iraq, which was partially offset by an underweight in Malaysia, Nigeria and Vietnam.

We like high yielders with idiosyncratic drivers such as Argentina (displaying a recovery story driven by political transition), Brazil (impeachment momentum), Pakistan, Mozambique and Ghana. On the other hand, we hold an underweight in Lebanon on the grounds of less supportive technicals and elevated political risk, and on Morocco, due to supply & geopolitical risks.

Still constructive on local debt

Most EM central banks in Asia and CEEMEA (commodity-importing regions in general) have policy room to remain accommodative, especially after the decline in oil prices.

However, the overall inflation picture remains favourable. In Latin America, the inflation picture is more mixed, with inflation pressures expected to subside in Brazil, but still building in Colombia, Chile and Mexico.

As a result, we are positive on all high yielders with a bias to Latam such as Brazil, Mexico, Colombia, Russia and Indonesia. A benign inflation outlook with favourable base effects and a tight monetary policy should keep favouring the belly to long end. Contrary to that, we hold an underweight on Thailand (tight valuations, fundamentals deterioration, political risks, higher sensitivity to the Chinese slowdown) and Peru (tight valuations and presidential election uncertainty).