Emerging market bonds shrugged off recent trade war-related concerns to strengthen in June. Local currency bonds, measured by the JP Morgan GBI-EM Global diversified index, returned 5.5% during the month, outperforming hard currency bonds, measured by the JPMorgan EMBI index, which posted a return of 3.4% (all in US dollars). The strengthening of emerging market currencies against the US dollar provided a tailwind for local bonds.
Markets responded to the US Federal Reserve (Fed) giving its strongest signal yet that it is turning dovish. Earlier this year we wrote that, with the US cooling and interest rates approaching a likely peak, a new cycle in emerging markets was drawing near. These latest comments from the Fed suggest the next cycle may begin even sooner than we thought. We cover the Fed’s move in more detail on our Emerging Perspectives site.
Renewed hopes of US-China trade deal also lifted emerging market sentiment as both countries agreed to hold bilateral talks during the G20 summit.
After rallying in May, Argentinian assets were again among the top performers in June, as noted in the Latin America section.
Meanwhile, in Turkey, a resounding win for opposition party, CHP, in Istanbul’s election re-run may have been an own goal for the ruling AKP, but it restores some faith in Turkish democracy, reinforcing our view that a Venezuela-like demise is unlikely. However, Turkey’s future rests on Erdogan’s next move: will he remain combative or is this a tipping point that forces a shift in focus to fixing the economy? Time will tell. Turkish bonds performed well over the month but we remain cautious over the long term.
We retain a positive long-term outlook for the asset class given the strength of many emerging market economies and the fact they are generally earlier in their cycle than many of their developed market peers.
Nearer-term, while the global economic backdrop remains subdued, we expect the recent shift to a more accommodative monetary policy stance across emerging and developed markets to support emerging market assets to varying degrees.
We still believe most emerging market assets are attractively valued relative to developed markets. And recent market moves have amplified the dispersion between higher and lower rated emerging market assets, with the latter presenting some particularly interesting opportunities to active investors.
Our overall risk positioning is moderately long.
From a top-down perspective, we are neutrally positioned in local bonds and overweight hard currency bonds and currencies.
From a bottom-up perspective we currently favour local bonds from low-yielding and low-risk (investment-grade) countries as we expect these to benefit the most as interest rates fall in response to a more muted global growth backdrop. In hard currencies we favour higher-yielding, attractively valued markets, which are driven more by their own fundamentals than global newsflow.
*Keep an eye on our Emerging Perspectives page for forthcoming insights.
Past performance is not a reliable indicator of future results and all investments carry the risk of capital loss.
This content is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contains statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual outcomes may differ materially from those stated herein.
All rights reserved. Issued by Investec Asset Management, July 2019.
Peter Eerdmans, Head of Fixed Income and Co-Head of Emerging Market Sovereign & FX and Mike Hugman, Portfolio Manager, EM blended debt
The statement that “there is no Planet B”, used by environmental activists everywhere, underlines the urgent challenge facing humanity. The degradation of nature threatens the stability of both the natural and human-made systems that underpin our livelihoods, our food security and our economies. There is still a limited opportunity for us to reverse the decline of the natural world. And to achieve the vital progress required, all stakeholders, including financial institutions, must now actively play their part.
Sovereign bond markets are a particularly influential link in society, because they set the price of risk and fund governments and other state entities. Yet to date, investors in sovereign debt have been slow to lend their weight to efforts to save our natural world, perhaps hiding behind the mistaken belief that it is not their business. Nothing could be further from the truth. It is absolutely investors’ business. We can and must make a meaningful contribution, by fully integrating environmental considerations into our investment processes and government-engagement strategies.
At the end of 2018, an estimated US$66 trillion of sovereign debt was outstanding, constituting close to two-thirds of the global bond market. Given the size of this asset class and the profound influence bondholders can exert on governments, the engagement of sovereign debt investors in the campaign to save our only habitat as humans will be critical in moving towards the sustainable management of our planet’s environment and natural resources.
Addressing environmental risks is in the interests of sovereign debt investors just as much as other investors, not least because it is increasingly clear that factors relating to nature and climate change can influence the sustainability and volatility of growth over the long term. The evolution of our ecosystem will, in turn, shape an individual government’s ability to generate revenues to repay its debt; this capacity will be a key driver of sovereign credit ratings and sovereign bond returns.
Bluntly put, how well – or badly – our governments manage our planet is having an ever more direct impact not just on the price of risk but ultimately upon the price of government. Investors can reinforce their realisation of this fact.
The challenge for investors is that sovereign-debt risk models typically do not integrate environmental factors comprehensively, often relying on broad proxy indicators that may mask the complex nature of the threats facing a given country. We need better tools to measure environmental risks, and it will take a collective effort to develop them.
To this end, WWF and Investec Asset Management recently teamed up to explore the application to sovereign-debt investing of spatial finance – an emerging field that brings together geospatial data (essentially, any information with a geographic component), Earth observation (e.g., satellite imagery) and financial analysis.
This is a nascent area, but it has the potential to transform sovereign-debt investors’ ability to understand the relationship between environmental factors and economic performance. For example, satellite imaging can be used to make up-to-date, accurate assessments of the condition of economically vital natural assets such as forestlands and river systems. It can also be used to check governments’ adherence to their environmental commitments.
Just as importantly, robust, credible and timely environmental data should facilitate investors’ engagements with bond-issuing governments. Through constructive discussions, investors can help countries forge a path towards sustainable development.
Investors are only just beginning to explore the potential of spatial data. But by working together, the investment community can greatly accelerate the development of the tools we need to assess accurately environmental risks. And as more of us embrace these analytical techniques, sovereign debt markets will more fully price in environmental risks. That will give governments greater incentive to implement fiscal agendas that serve their people and our planet, humanity’s one and only Planet A. Read more here.
Trade tensions continued to dominate the market’s attention, with sentiment improving towards the end of the month as it became clear Presidents Trump and Xi would meet at the G20 in Osaka. While there was no roll-back of current tariffs, the language was generally conducive to an improving dynamic on negotiations. We believe it’s in both parties’ interests to see China’s currency hold stable or even strengthen slightly, so we remain overweight in the renminbi.
Outside of trade, the data out of Asia continued to disappoint, particularly on export and manufacturing-related industries. This continues to support our underweight currency positions in the more open economies of Taiwan and Malaysia, while we recently initiated an underweight position in the Korean won.
The market generally priced in further rate cuts, in conjunction with more dovish rhetoric from core global central banks. Singapore rates moved in sync with global rates, but with a much milder magnitude. We used this underperformance to close our underweight duration position.
Thailand’s solid current account position continues to underpin strong performance in the Thai baht. We believe there is little the central bank can do to stem the currency strength, especially as the US Treasury widened its scope of countries deemed to be currency manipulators, so we moved overweight the currency. And as we don’t expect as much of a rate cutting cycle as what is priced in by the market, we remain underweight duration in Thailand.
We believe the Philippine peso will come under pressure later in the year following the elections and the delayed 2019 budget. However, for the time being we believe the currency may continue to perform well versus peers. Therefore, we closed our underweight.
In Indonesia there have been several positive developments, namely Jokowi winning the presidential vote, along with a ratings upgrade by S&P. However, the country’s current account deficit remains at concerning levels following a record trade deficit in April. We believe the currency will underperform and remain underweight the currency.
Growth data in Latin America continued to be lacklustre through the quarter, with inflation data generally modest. This backdrop has supported bond markets across the region and kept the performance of regional currencies muted.
Across our key markets, politics continue to play an outsized role. We are moving closer to the election in Argentina (more below); Brazil and Chile are grappling with social security and pension reform respectively; and the new Mexican administration is facing the realities of balancing populist ideals with weaker growth and the vagaries of US President Trump.
In Argentina, President Macri selected a moderate Peronist to run alongside him for vice-president in the forthcoming elections, potentially increasing his chances of winning by broadening his appeal. The country also posted strong fiscal results so is on track to hit IMF targets for continued disbursements. Furthermore, manufacturing and construction data releases confirmed that we have passed the low point for Argentina’s economy.
In Chile we went underweight when the currency moved to the bottom of our trading range but we have shifted to an overweight now that the currency is offering value and it has moved to the top of our trading range.
We remain positive on Egypt’s structural reforms and the country offers high yields. However, increased foreign investor positioning and strengthening of the pound means that we expect returns to be more moderate in future so we locked in in some outperformance and cut our exposure.
A recent trip to Ghana left us with a mixed picture of the prospects for the country’s assets. On one hand, positive structural changes and robust growth should support economic fundamentals; on the other, we perceive an increased risk of pressure on the government to ramp up spending, following three years of austerity. And as the election gets closer the risk of the government succumbing to such pressure is also elevated.
We increased our exposure to Kenya’s hard currency bonds given the continued progress on the fiscal side, solid economic fundamentals and attractive valuations relative to similarly rated peers. We also see the latest budget as the first step to re-engaging with the IMF for a stand-by facility, which would further reduce market uncertainties regarding Kenya’s macroeconomic outlook.
Activity data from the region implies that the strong growth momentum in CEE at the start of the year probably waned in the second quarter and is likely to weaken further, mainly due to external factors.
In Hungary, inflation pressures eased somewhat in June on the back of falling fuel prices and a slowdown in the growth of excise duty goods prices but underlying inflation remained broadly stable at elevated levels. The current data combined with the global economic slowdown allowed the central bank to maintain its wait-and-see approach for the coming months. We remain overweight in local and hard currency debt.
In Poland, the central bank held interest rates at its July meeting and presented a new Inflation Report that raised its CPI and GDP projections for both 2019 and 2020, but crucially still holds for inflation to remain within the target band and to fall to the 2.5% target in 2021. We remain underweight Polish debt.
In the Czech Republic, the central bank kept the policy rate unchanged at 2%. Governor Rusnok didn't completely rule out a rate hike in the coming months, stressing, however, that economic conditions would need to improve visibly before that happens. We maintain our overweight position in Czech local debt.
In Romania, the parliament approved the new board of the central bank (NBR) with five out of nine members of the current board serving for another five-year term, among them Governor Isarescu. We expect the NBR to maintain a relatively tight monetary policy, as it seems increasingly concerned about the rising external deficit.
In Serbia, strong economic performance coupled with solid fundamentals and relatively high yields are attracting an increasing number of investors, as evidenced by the strong demand in recent bond auctions. We remain overweight.
In other sovereign credit markets in the region, we maintain our overweight exposure in our high conviction markets including Croatia and Georgia.
We cut our underweight position in the Turkish lira back to neutral ahead of the Istanbul election mentioned in the market review section. The election result was a positive and resulted in locals slowing their buying of US dollars. Inflation surprised to the downside. We continue to see risk in the fiscal outlook with the government running very low cash balances and a deficit that is well wide of target so we have returned to cautious positioning.
We continue to be overweight Russia. The central bank managed to cut rates and indicated that it could continue cutting until it reaches its “Neutral” nominal policy rate (which is around 6-7%) next year. Inflation remains benign. Growth data has been a little weak recently but we remain encouraged by the long-term fundamental outlook for this economy, especially inflation.
In South Africa President Ramaphosa’s State of the Nation address was disappointing in its lack of detail on a plan to turn around struggling state-owned enterprise Eskom. The government’s approach seems to be to front load the R230bn bail-out which was scheduled to happen over 10 years. South African local bonds underperformed (we are neutrally positioned) but the rand was strong, rallying with the improved emerging market sentiment, the weaker dollar and better terms-of-trade. We are underweight credit which rallied over the month. The central bank kept rates on hold but shifted to a more dovish stance.
In Ukraine our overweight credit position performed well. The constitutional court ruled that the local elections could be held early in September, a boost to President Zelensky’s Servant of the People party. Zelensky held constructive conversations with local banks and indicated he was keen to keep working with the IMF.
Israeli local bonds rallied with global yields falling and the shekel strengthened. The fiscal outlook has deteriorated with the budget deficit widening. We await the election re-run which is due in September.
In the Middle East, geopolitical tensions remained high, with further attacks on oil tankers and the shooting down of a US drone.
In the investment-grade space we retain our overweight exposure to Qatar where we see value given the economy’s low fiscal and external breakeven oil price, expenditure discipline and robust non-oil growth. With regional spreads relatively high given the geopolitical backdrop we added exposure in longer-dated Saudi Arabian bonds, which were attractively valued relative to peers despite the cushion of a sizeable net asset position.
In high yield, we remain overweight in longer-dated bonds in Jordan. Jordan has one of the steepest yield curves in the emerging market investment universe and we expect this to normalise over time given the country’s commitment to IMF-backed structural reform and correcting fiscal and external imbalances.
We remain underweight other high-yield markets in the region, most notably Lebanon. Despite spreads reaching historically wide levels, we still do not find the risk-reward profile of Lebanese bonds attractive. Commercial banks rebuffed the central bank in its attempts to lower the interest burden with a debt swap, in what was a significant element of the authorities’ plans to move the country towards a sustainable debt path. The 2019 budget contains some measures aimed at fiscal consolidation but has yet to be approved by parliament. Even strong implementation (unlikely in itself) will not be enough to stabilise the country’s debt-to-GDP ratio on its own, in our view.
Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
Investments carry a risk of capital loss.