Fixed Income  

Careful assessment still needed for EMD

This article is part of
The Guide: Fixed Income

Careful assessment still needed for EMD
Performance of EM government bonds over the past 12 months

Emerging markets have always been considered a volatile place for investors, as demonstrated following the 2013 taper tantrum and the renminbi devaluation in 2015. 

The countries with the largest current account deficit are often the most vulnerable, and frequently classed as boom and bust economies. Yet yield-hungry investors should not overlook attractive opportunities to access the economic vibrancy of the emerging world. 

Emerging market debt has become a key part of the fixed income portfolio at Carmignac over the past 12 months, supported by China’s macroeconomic stabilisation, a rebound in commodity prices, improving current account balances, and higher yields than in developed countries.

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A case in point is Mexico, where the real yields are very high, even for the emerging market category. After being buffeted by the bellicose overtures of US president Donald Trump’s election agenda, the country’s economy seems to be recovering. The Mexican peso has appreciated 15 per cent against the dollar since the start of the year. 

While the North American Free Trade Agreement stands a good chance of being tweaked, the kind of no-holds-barred fight that could do major damage to Mexico’s economy and exports appears to be a much less likely prospect with a more pragmatic White House.

On the economic front, Mexico’s first-quarter real GDP growth at 2.8 per cent year on year confirmed that economic expansion continued at a healthy pace, despite US policy-driven uncertainty and a significant spike in inflation. Indeed, Mexico’s central bank continues to be vigilant about inflation and has implemented nine rate hikes since late 2015, demonstrating its commitment to its central objective of anchoring inflation expectations.

Meanwhile, Brazil presents attractive disinflationary and deleveraging trends. The current account balance has improved significantly and structural fiscal reforms have boosted public finances. 

Argentina is more of a special situation. The country is in a big transition initiated with the arrival of president Mauricio Macri, following 15 years under the Kirchners, with more reforms expected.

It could be said that these emerging economies are at the sweet spot of the current cyclical recovery that started in early 2016, so the risk of the recovery rolling over in the US and China has to be taken into account.

As the world’s second largest economy, China needs particular attention in this respect. The current tightening of credit in the Asian country is an important risk factor since it is a much more volatile economy than the US. The good news is that the reduction is controlled and managed by the government, which, as ever, wants to preserve stability in the country. 

However, since the Chinese economy seems very dependent on credit, any reduction of credit growth will result in some economic slowdown. The difficulty is to correctly dose the withdrawal of the stimulus measures. In the longer term, the challenge is to retain the huge savings of the Chinese population within the country. The weakening dollar is a supporting factor in this respect, but also a key variable to monitor.