Fixed Income  

Fund Review: Uncertainty over Trump points to volatile year for EM debt

Fund Review: Uncertainty over Trump points to volatile year for EM debt
Monthly net retail sales for the IA Global Emerging Markets Bond sector

Emerging markets in general have been out of favour for some time, but emerging market debt (EMD) has had the odd bright spot.

The start of 2016 was tough for the sector, with low oil prices and uncertainty in key economies such as China. But investor sentiment started to turn as the year progressed, with the IA Global Emerging Markets Bond sector recording positive net retail sales for six of the 12 months to November 2016, posting a high of £91m in July 2016. 

As Donald Trump takes on the US presidency, suggestions of trade protectionism measures could see 2017 being an even more volatile year for emerging market bonds. 

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Pierre-Yves Bareau, chief investment officer for EMD at JPMorgan Asset Management, says: “It’s fair to say that Mr Trump’s surprising election victory has radically altered the investment landscape and has ushered in something of a paradigm shift. Gone is the broad narrative of ‘lower for longer’, and in its place a narrative shaped by expectations of higher growth, inflation and interest rates in the US. 

“Emerging market local currencies saw the strongest post-election reaction, with an immediate repricing of currencies and yields, and especially in those markets deemed most exposed to a radical shift in US trade policy, such as Mexico. The reaction in US dollar-denominated emerging market sovereign and corporate credit markets was more muted, with only minimal spread widening.”

Mr Bareau continues: “We think markets are already attaching a degree of risk premium to valuations accounting for the heightened uncertainty, but there remains the prospect of further repricing as Mr Trump’s policies on economics and trade crystallise early this year and are implemented later in the year.”

Claudia Calich, EMD manager at M&G Investments, adds: “Despite a year of high political turmoil, emerging market assets proved surprisingly resilient to the various global events, even with rising core government yields in the second half of 2016.”

Looking ahead she notes: “Politics and economic policy developments in the US, as well as key elections in Europe, are the major foreseeable events to be digested in 2017. Monetary normalisation continues in the US, and treasury yields – while not cheap on a long-term basis – have at least adjusted closer to fair value in the near term and should prove to be less of a headwind to returns. This is relevant as spread returns should also be much lower than in 2016.”

However, Colm McDonagh, head of EMD at Insight Investment, says a key determinant for bond markets in 2017 is the success, relative or otherwise, of the normalisation of developed market bond yield curves. 

“For emerging market economies, a more positive growth outlook would outweigh a developed market duration-induced repricing, if the latter occurred in a reasonably measured fashion,” he explains. 

“Countries that have allowed economic adjustment to occur through their currencies will benefit; those that still exhibit rigidities will not. Regardless of the credit or duration cycle, the depth of the emerging bond universe continues to grow, and the structural emergence of new issuers, better market access and growth of investor base will continue at pace.”