Fast rally on external EM debts

EMERGING MARKET BOND STRATEGY

The emerging market relief rally (Chart 4) was fuelled by a 10% jump in oil prices (expectations of production freezes) and dovish Western central banks (dovish ECB and prudent US Fed). Moreover, the EM specific developments in Argentina (government closing in on resolution with holdouts), Brazil (rising probability of impeachment) and Mozambique (investor friendly bond restructuring) were also supportive.

After this rally, we are therefore more cautious. Risks to emerging markets from China slowdown, Fed normalization and commodities have subsided since the start of the year. At the same time, technical factors have turned less supportive as the net new supply is now expected to be positive for the year and issuance is likely to be elevated in 2Q-3Q.

We like Argentina which displays an idiosyncratic recovery story driven by political transition. We added exposure to Brazil (impeachment momentum), and Egypt (to cover the underweight after the credit positive currency devaluation) as well as Indonesia (via a quasi-sovereign Pertamina) and Montenegro. On the other side, we took partial profits in commodity exporters like Gabon, Ecuador, Iraq and Zambia.

On a mid- to long-term perspective, we are convinced that, with yields at 5.8%, external emerging market debt remains an attractive investment in a global fixed income context.

More constructive on local debt, especially in Eastern Europe

Most EM central banks in Asia and CEEMEA (commodity importing regions in general) have policy room to remain accommodative especially after the further decline in oil prices. In Latin America, the inflation picture is more mixed with inflation pressures expected to subside in Brazil but are still building in Colombia, Chile and Mexico.

As a result, we are positive on Brazil (strong favorable base effects on inflation and market now expects a faster resolution of the political gridlock). We also favour Eastern Europe local debts such as Hungarian and Romanian ones, because real rates are still attractive.

We turned negative from positive on Russia. After massive performance, see some overshooting. We remain cautious on Thailand and Peru on tight valuations, elevated political uncertainty and higher sensitivity to the Chinese slowdown (Thailand only).