Market sentiment improved in the second half of December, following the more subdued month of November. Currency strength helped boost the EM local currency bond market, with EM hard currency sovereign and corporate bond markets also rising.
A combination of factors helped markets end the year on a strong note. Positive steps towards the signing of ‘phase one’ of a US/China trade deal boosted sentiment. And improved economic data from China and the US helped allay fears surrounding the health of the global economy. The UK election result also removed some uncertainty around the UK’s departure from the EU, boosting markets in central and eastern Europe, in particular.
In Argentina, recently elected President Fernandez appointed a respected economist as economy minister. The market welcomed this news and the new emergency bill that gives sweeping powers to the new administration – a move that seems likely to improve the country’s fiscal trajectory.
Ecuador’s hard currency bonds regained lost ground, as the tax reform was passed with a significant majority. This met with praise from the IMF, which subsequently released US$500 million as part of its lending programme.
Brazil, Chile and Colombia saw their currencies strengthen and local currency bond prices end a volatile month higher. Factors contributing to the rise in Brazil’s bond prices included a rate cut by the central bank, and rating agency S&P upgrading the country’s outlook to positive.
Elsewhere, the Russian ruble also benefited from investors’ increased risk appetite, reaching an 18-month high against the US dollar during the month. Russian assets were among those that gained from a deepening of production cuts by OPEC and subsequent rise in oil prices.
The Ukrainian hryvnia continued to strengthen. The IMF agreed a US$5.5 billion three-year programme, praising the country’s recent reforms. Also, Ukraine’s central bank surprised the market by cutting rates by 200 basis points to bolster growth, and this boosted bond prices.
In contrast, Turkey’s lira and local bonds weakened. The country’s strained relationship with the US came under the spotlight as the US Senate Foreign Relations Committee voted to send sanctions legislation to the Senate for a full vote. India’s local currency bonds also sold off. India’s central bank kept interest rates on hold. The consensus expectation had been for a rate cut, given the weak state of the Indian economy, but higher-than-expected inflation meant the central bank’s hands were tied. The rupee started the month relatively well but widespread protests against the bill to amend India’s Citizenship Act subsequently weighed on the currency.
Top down views and outlook
2019 was a positive year for investors in emerging market debt. While the path was far from linear, the overall outcome was robust, with markets posting double digit returns in US dollar terms.
As we wrote in June, the US monetary policy tightening cycle came to an end before many investors expected, removing a key headwind for emerging market debt. Furthermore, the global liquidity backdrop looks positive as we enter 2020, with US inflation remaining soft and the US Federal Reserve continuing to extend liquidity.
Challenges were by no means absent last year, most notably for emerging market currencies, with US-China trade conflict oscillations weighing on global business sentiment and growth. However, this particular headwind looks like it should fade in 2020, with a ‘phase one’ deal due to be signed imminently. This should help support the global and emerging market growth outlook and we have seen near-term economic indicators turning somewhat more positive, particularly in emerging markets.
Given the constructive backdrop, we remain positive on the asset class and overweight beta.
We have moved further overweight in emerging market currencies (EMFX), which we feel will be supported by improving macro fundamentals and further equity inflows (on a full-year basis, emerging market equity inflows were flat in 2019).
We also retain a positive view on hard currency debt, where we still see value in select markets, particularly in some positive reform stories among high-yield markets.
We think it's still a supportive environment for local currency bonds, given the global liquidity backdrop and soft inflation in emerging market economies. However, nominal valuations do seem somewhat stretched. Therefore, given our overweight exposure elsewhere, we have pared back our target position to slightly underweight local currency bonds.
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