Despite volatility, 2016 proved to be a very strong year for emerging market debt. Hard currency bonds, local currency bonds and EM corporate debt all realised returns of 10% or more. Going forward, we believe emerging markets can continue to do well in an environment characterised by rising US bond yields and a strong US dollar.
Source: J.P. Morgan, Barclays, Dec 2016
An important fundamental development in EM has been the reduction in external refinancing needs, enabled by a sharp reduction in current account deficits that took place in most EM countries.
Inflation in EM is declining after a few years of being above target levels, while real interest rates are still high. EM currencies are also significantly below their long-term averages.
All these are supportive factors for EM. We believe there will be further improvement in the EM growth outlook, driven by the recovery in commodity prices.
Emerging vs developed markets
Some major EM economies will be coming out of recession. Russia and Brazil, in recession for the past two years, will likely start showing positive growth numbers in 2017. Chinese growth will remain well-supported by monetary and fiscal policies. What’s more, the positive growth differential between emerging and developed economies is expected to start widening again.
While the continued improvement in economic activity in the US increases the risks of additional monetary tightening, the overall yield levels are likely to be anchored by persistently and substantially lower yields in other major developed markets like the Eurozone and Japan. Fiscal spending under the Trump administration in the US may face obstacles in the congress, and will likely be diluted to reduce its impact – which is beyond the short-to-medium term.
Despite the recent uptick, inflation should stay benign in most of the developed world, especially the Eurozone and Japan. Improving growth amid a benign inflationary backdrop should not be disruptive for fixed income in the near term.
More importantly, economic growth in emerging market economies has stabilised amid relatively high real interest rates, undervalued currencies, and stable-to-improving commodity prices. This combination of factors should offer the EMD asset class a better balance against any potential headwinds.
Within EM, China’s growth momentum remains robust. The latest indicators such as PMIs, trade, and monetary data suggest growth momentum has continued into 2017. We believe a relatively stable RMB/USD exchange rate will continue for a while because the authorities would prefer to keep the currency stable in order to anchor onshore financial market stability. Externally, the US-China trade relationship under the Trump-Administration remains the key concern.
In short, we continue to see some green shoots for more stable and in some countries even improving EM fundamentals partially helped by stable-to-improving commodity prices. This improvement in fundamentals is, however, balanced against valuations that are closer to fair and potential increase in risk from US policies under Mr Trump. In the medium term, US policy news, developments in China and European politics could continue to pose some risks.
Marcelo Assalin is head of emerging market debt at NN Investment Partners
Why NN Investment Partners for EMD
NN IP has a long and successful track record in managing the full spectrum of emerging market debt. NN IP has professionally managed hard currency sovereign debt since 1993, local currency money markets since 1998, hard currency corporate debt since 2003 and local currency bonds since 2007. We have consistently generated attractive risk-adjusted returns for our clients. The continued success of our investment strategies is due to team effort and our investment process which focuses on medium-term fundamentals in emerging markets with an emphasis on diversification. The process is executed by a team of EMD experts across three regions.
Our EMD strategies have received multiple awards over the years. In 2016, the NN (L) Emerging Markets Debt (Hard Currency) fund won the Lipper Awards in Germany, Austria and Switzerland in the category Emerging Markets Bonds Global, in both 5- and 10 – year time horizons. In Asia, the fund received the award for Best Global EMD fund on a 10-year basis at the Asia Asset Management Best of the Best Performance Awards in Singapore.
Disclaimer
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