04 JUN


Fixed Income , Topics

Still overweight on Hard Currency credits


EMD posted a negative monthly return, driven primarily by a 10Y US Treasury correction as the 'flight to safer' core rates theme from March reversed and the USD strengthened. The global market environment remained challenging, with multiple events elevating uncertainty – trade-protectionist US policies eliciting reaction from the main trading partners (the Eurozone and China), rise in geopolitical/idiosyncratic risks around the conflict in Syria, the latest US sanctions against Russia, and the early Turkey elections. As a result, EM spreads widened by 9bps (-0.4% in EMD HC terms) in spite of the constructive oil backdrop (+7.0%).

External risks to EM remained elevated at the beginning of 2018 but so far the risks around US monetary policy normalization and fiscal expansion been offset by the synchronized global growth recovery, the solid performance of commodities, and investor appetite for risky assets. The case for EMD remains supported by the accelerating EM growth, limited China risks and improving fundamentals. Asset class valuations are still being extended on an absolute basis but remain attractive versus US credit. Asset class flows printed a record high in 2017, but after a disappointing 2013-15 period. We expect the solid asset class inflows to persist in 2018.

We retain an overweight in Hard Currency Debt, and are constructive on commodity exporters like Angola, Ecuador, Kazakhstan, Nigeria, Petrobras (Brazil) and Pemex (Mexico). We also maintain an exposure to specific idiosyncratic re-rating stories (high yielders with positive reform momentum) like Argentina, Ukraine and Egypt. In spite of the recent troubles witnessed in Argentina (May’s currency run), we remain positive on HC sovereign debt (which now appears to be relatively cheap) as President Macri's IMF approach for a precautionary SBA (Stand-by Agreement) is positive and could resolve external funding requirements for 2018 and 2019. We hold a position in Kenya on the back of the decline in political risks after the opposition presidential candidate accepted the results of the recent presidential elections and following a significant risk premium re-pricing.

Our underweights include US treasury-sensitive credits with tight valuations such as Panama, Peru, Chile, China, Uruguay and the Philippines.


Overweight Local Rates position, select higher-yielding Local Rates markets are still attractive

The disinflation theme has run its course in lower-yielding EMs, as less negative output gaps and the rebound in energy prices should put upward pressure on prices. However, the high real-rate differential to the US should continue to play in favour of local duration in higher yielders, with subdued inflation and scope for central bank easing. We are OW local duration via OWs in High Yielders vs. Low Yielders.

Specifically, we remain overweight select high-yielders that are supported by high real rates and constructive disinflation dynamics (Brazil, Russia). During March, we strengthened the overall EM high-yielder rates position via additions in Colombia, Mexico and Uruguay). We also favour South Africa, which is benefiting from positive election results and a slower expected inflation. We are underweight lower-yielding local rates markets in Asia (Thailand and Malaysia) and CEE (Poland, Hungary and Romania).