Following a turbulent August, markets were generally steadier in September. Local currency sovereign bonds benefited from a slightly weaker US dollar (the JP Morgan GBI-EM Global Diversified Index rose by 0.96%). The corporate credit market rose (the JP Morgan CEMBI Board Diversified Index finished up 0.63%) but the hard currency sovereign bond market retraced some of August’s gains as the rise in US Treasury yields weighed on bond prices (the JP Morgan EMBI fell by 0.46%).
Trade tensions abated somewhat in September, with US/China talks continuing behind the scenes. China agreed to up its imports of US agricultural products while the US agreed to delay its next round of tariff increases by two weeks, ahead of China’s 70th National Day celebrations.
Other geo-political news stole the headlines in September, not least the attack on a major oil facility in Saudi Arabia. This resulted in oil prices spiking, but as supply concerns eased the focus shifted to weaker global growth potentially dampening demand for the commodity. The resultant fall in oil prices benefited oil importers such as India.
While the calmer trade backdrop supported some Asian currencies, the manufacturing slowdown in the euro zone weighed on currencies in neighbouring central and eastern Europe, particularly the Hungarian forint.
Weakness in manufacturing data is now a global phenomenon that is keeping many central banks in dovish mode, with Brazil seeing its interest rates cut to historic lows.
Turkey was a top performing market as a relatively restrained cut in interest rates assuaged many investors’ concerns over central bank credibility. However, we think many question marks remain over monetary and fiscal policy in the country.
One market where the central bank’s credibility is unlikely to be questioned is Russia. There we saw another sensible interest rate cut and expect soft inflation data to allow for more of the same. This creates a positive outlook for the country’s bond market, since bond prices rise as interest rates fall.
Zambia was among the high-yield bond markets that benefited from investors’ improved sentiment and risk appetite. The country’s assets also strengthened on signs that the finance minister will proactively engage with the IMF to turn around the economy.
Last but by no means least, Argentinian assets made a recovery in September as the market welcomed the government’s plans to shore up currency reserves and investors took comfort in talk that debt might be reprofiled (rather than face a principal haircut) under the expected new political regime.
We maintain our cautious view for the asset class in the near term and we remain close to neutral in our overall risk exposure, preferring to focus on active bottom-up relative value positions.
Central banks across the globe are entering a monetary policy easing cycle, reflected in a fall in core interest rates. This is supporting investors’ hunt for yield and highlighting the relative attractiveness of emerging market debt.
Of course, the move in core rates is a reaction to the slowdown in global growth. The outlook for the global economy remains soft, with data prints continuing to weaken, albeit no longer surprising to the downside. The consumer sector remains a bright spot, but this will start to come under pressure unless we see an improvement in business confidence and a pick-up in investment plans. The outlook for both will be determined in large part by the trajectory of the US-China trade dispute, with a possible ‘hard Brexit’ providing a secondary risk to the European, if not global, economy.
We would also stress that while we still see relatively healthy fundamentals in emerging market economies, with US growth indicators outperforming the rest of the world it is a mixed environment for the asset class performance over the short term.
Given the importance of the emerging (vs. developed) market growth differential for emerging market currency (EMFX) performance, the sluggish growth outlook and Trump-related risks keep us slightly underweight EMFX for now. This is despite the significant value we believe emerging market currencies offer on a long-term, structural basis. We offset this positioning with an overweight stance in hard currency bonds. There we still see some value given improving credit fundamentals overall, particularly in non-oil exporting, high-yield reform stories. We are neutrally positioned in local currency bonds where the risks seem quite balanced: local-yield valuations look quite stretched, although the soft growth and inflation environment provides ample scope for further easing by emerging market central banks
As always, please keep an eye on our Emerging Perspectives page for forthcoming insights. You can sign up to receive alerts here.
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We have written quite extensively about China this year, but some of the lesser-known names in Asia’s diverse investment universe are more than worthy of investor attention. Not least China’s northern neighbour, Mongolia. We asked our Asia expert, Mark Evans, to share some of the key takeaways from his recent trip.
With its population of over 3 million people, a land mass three-times that of France, almost 70 million farm animals and some of the world’s largest untapped mineral deposits, it’s hard not to be impressed by Mongolia. There’s a real sense of opportunity for this developing economy.1
Mongolia’s enviable stock of natural capital – minerals and animal products – provide solid foundations for a higher-quality growth path. Infrastructure investment will hold the key to unlocking the country’s full potential, so careful and targeted use of the wealth harnessed from its natural capital will be vital. Although a socialist past does not typically lend itself towards the creation of the sort of institutional framework needed to underpin this, Mongolia is not short of steady hands to guide it: the IMF and World Bank are just two of the institutions currently working closely with the country.
While much remains to be done – not least on corruption, social housing and pollution – various initiatives are in progress to improve the population’s living standards. In short: Mongolia seems committed to forging a sustainable growth path for its economy and people, leading us to believe it is heading in the right direction from an ESG perspective.
The key positives that shone through for us were the government’s commitment to fiscal prudence and the strong support it has from the international financial institutions.
Many developing countries fall into the trap of overextending their public finances, often driven by political motivations ahead of elections. Mongolia did just this in 2016, when it racked up a humiliating fiscal deficit of 18%. However, thanks to a commodity price rebound and expenditure restraint, within two years the government printed a fiscal surplus, significantly better than IMF projections. Indeed, the IMF noted that the adjustment has meant the history books have been re-written.
Furthermore, a meeting with the Ministry of Finance suggested the indignity the country suffered in 2016 has left it with no appetite for a repeat. Ministry of Finance estimates now point to a continuation of the impressive trend for Mongolia’s government debt/GDP ratio, potentially falling to 40% in 2021 from over 60% in 2018. And by accumulating assets in two sovereign wealth funds, the country has proven its desire to save for a rainy day.
Thanks in no small part to this fiscal restraint, Mongolia enjoys strong support from the key international financial institutions. A planned IMF lending programme – currently on hold pending the completion of an audit on bank recapitalisation and subject to the go-ahead by Mongolian authorities – is entirely feasible, in our view. The IMF representative we met pointed to the country’s impressive macroeconomic performance. And for its part, the World Bank has taken the unusual step of extending $100 million of support to Mongolia, highlighting the credibility earned by its policymakers.
The first key risk relates to the Oyu Tolgoi copper mine in the South Gobi Desert, which has added $2.4 billion to Mongolia’s public coffers since 2010. The government is currently scrutinising its agreement with the mine’s majority owner, which introduces a risk – albeit small, by our estimates – of deterring future investment. To further muddy the outlook, recent analysis revealed greater complexity and higher costs than initially estimated for the second phase of the mine’s development; the extent of potential delays and financial impact won’t be clear until investigations conclude in 2020.
Second, Mongolia remains very vulnerable to a potential sharp drop in commodity prices. And third, although partly mitigated by the prudent fiscal stance as noted above, forthcoming elections loom large and may be called as early as the end of October. This introduces a risk that the government will abandon its fiscal prudence in favour of making vote-winning handouts. But we think this is unlikely, given the 2016 experiences mentioned above. Plus we get the sense that Mongolia’s citizens want good macroeconomic policy, not cash handouts which end up costing them more in the long term.
More broadly, investors should be mindful that young democracies often make missteps in their journey to greater things. We doubt Mongolia will be immune to such growing pains so the path to prosperity is unlikely to be smooth.
To conclude: while some key reforms are needed to put the economy firmly on the right track, there is much for investors to get excited about in this frontier market.
The summer’s trade tensions abated somewhat in September, as discussed in the Market review. While this calmer backdrop supported Asian currencies over September, our view remains that tariffs will rise over the coming months as the two sides’ (US/China) positioning is so divergent, keeping us cautiously positioned in Korea, Taiwan, India and Singapore.
Focusing on local currency bonds (i.e. rates rather than FX), we retained our exposure to China. Although high pork prices and a heated property market are making it hard for the authorities to cut interest rates at present, longer term we expect ongoing stimulus measures to support the gradually slowing economy. And we believe policymakers have sufficient room to maneouvre should the trade war escalate.
We also added to our overweight positioning in Indonesia as bond yields there have lagged the rest of Asia. With inflation well within the target range, the central bank continues to lower the monetary policy rate and we expect this to translate to higher bond prices over time.
Indian assets rose but this remains a story of economic fragility. The oil price correcting lower boosted the economy. Markets also welcomed the government’s latest measure to stimulate growth (corporate tax cuts). However, we doubt this move will make a significant impact as it won’t boost consumer demand – the country’s key growth driver. It will also put pressure on already strained finances. We remain uninvested in Indian bonds. Against the rupee, we are overweight the Philippine peso where we think growth is on more solid foundations, while high real interest rates and a contained current account deficit should support the peso.
We shifted to an overweight position in Malaysia’s currency – a relative value trade that we are funding through our underweight exposure to the Singapore dollar. We moved overweight the former as it became increasingly apparent the country would retain its place in the FTSE World Government Bond Index, thus avoiding significant investment outflows for the time being. We also believe Malaysia will benefit from trade and foreign direct investment diversion and fare well relative regional peers in the event of a trade war escalation.
Central banks in the region remained largely dovish, cutting interest rates against a backdrop of muted economic growth. The main exception was Colombia, where relative economic strength and balance of payment weakness meant rates stayed on hold.
While there remains a lot of uncertainty over what will happen under a Fernandez government in Argentina, the market took comfort in talk that debt might be reprofiled rather than face a principal haircut, as mentioned in the Market review. We added to our hard currency sovereign debt exposure in the country given the attractive valuations there (fears of a debt restructuring had weighed heavily on asset prices). However, we retain our cautious stance in local bonds and the peso.
In Brazil, the central bank cut interest rates to historic lows and the market is pricing in further cuts. We remain overweight local bonds and the currency, although corporate buying of US dollars have weighed on currency performance there. While social security reforms have been largely completed and asset prices reflect that, we expect Brazil’s administration to continue with its broader reform agenda, including the introduction of tax reforms. This is keeping us positive on the country. In contrast, ongoing delays to pension reforms in Chile are keeping us neutrally positioned there.
In Mexico the central bank cut rates by 25 basis points, with two of its board members voting for an even bigger cut. This led to the market discounting further cuts. We have added some exposure here, both to sovereign debt and Pemex bonds, and reduced our peso underweight. Our rationale: the government is adhering to its fiscal targets; relatively high real interest rates are helping to contain currency weakness and we don’t expect to see a Pemex rating downgrade this year.
Political turmoil continued in Peru but markets remained remarkably sanguine. We remain slightly overweight.
In Uruguay we took the opportunity of attractively priced new issuance to buy sovereign hard currency bonds, reducing our underweight positioning. We believe the forthcoming election is likely to herald fiscal reforms under a new administration.
The IMF carried out its review in Ecuador for the next release of funds. It found the country to have met all the necessary conditions, although it is waiting for the administration to present a reform package. We have increased our position as we believe the country’s debt will be on a sustainable and positive path should Ecuador continue to make economic progress in line with targets it has agreed with the IMF.
Improved investor sentiment boosted high-yield markets such as Senegal, Ghana, Egypt, Nigeria and Zambia.
Protests in Egypt highlighted how the path to sustainable growth can be painful, especially for the poorest in society as subsidies are removed. Egypt remains one of our favourite markets and we do not believe recent protests will escalate or become more widespread. With growth and inflation on such a solid footing we believe Egyptians will favour continued stability. September saw a further 100 basis point interest rate cut, which we think will soon take effect to further boost growth. We also see potential for further rate cuts. That said, we have trimmed some of our exposure to the Egyptian pound given the uncertainty that periods of societal unrest introduce.
Zambian asset prices gained as investors welcomed signs that the country’s finance minister will proactively engage with the IMF to work on turning around the economy.
We sold some of our holdings in Senegal’s euro-denominated sovereign bonds, which rallied following the European Central Bank’s announcement over monetary policy easing.
We sold all of our holdings in Nigeria as we have become increasingly negative on its structural dynamics. The government has not delivered on its economic recovery plan and there is a lack of clear economic policy direction. Nigeria now has a current account deficit.
In Kenya, where we continue to have hard currency (dollar) bond exposure, the new finance minister announced a budget which the market received relatively well as it contained credible plans to reduce the deficit through spending cuts.
The central bank of the Czech Republic kept interest rates unchanged through a 5-2 vote in its September meeting, adopting a more hawkish stance and pointing to persistent inflationary pressures. Activity data pointed to the deteriorating trend in manufacturing output continuing – unsurprising given weakness in the country’s main trading partners such as Germany. Moody's upgraded the country’s long-term credit rating by one notch to Aa3 with a stable outlook. We remain overweight in the country’s local currency bonds.
Economic growth in Hungary is expected to reach 4.5% this year and slow down towards 3.5% next year. The country’s fiscal picture remains solid with budget deficit targets for 2019 and 2020 of 1.8% and 1.0% of GDP respectively looking realistic. The central bank revised down its forecasts for core inflation and tax-adjusted core inflation in 2019-2020; however the September print was higher than its projection. We remain moderately overweight in both local and hard currency bonds.
The Court of Justice of the EU (CJEU) issued a ruling on Poland’s Swiss franc mortgage case that is broadly consistent with the opinion issued in May by the court's advocate general. A member of Poland’s central bank said the cost of the ruling will amount to between 20 and 30 billion Polish zloty, more or less in line with Moody's estimates but below those of local banks and the Polish Bank Association (ZBP), which sees cost of some 60 billion zloty. At the time of writing, polls were suggesting an outright win for the ruling Law and Justice (PiS)-led coalition in parliamentary elections scheduled for October 13th. We remain underweight in local and hard currency bonds.
Romania’s central bank kept the policy rate unchanged at 2.5%, reiterating its strict liquidity control pledge as inflation remains above target. Economic growth remained strong in the first half of the year but it is moderating, mirroring developments of major trading partners. The government estimated a slight fiscal adjustment and sees the 2019 deficit at 2.75% of GDP, but risks are clearly skewed to a larger deficit based on year-to-date revenue and expenditure data. We remain moderately overweight in local currency bonds and neutrally weighted in hard currency bonds.
The government and the central bank in Serbia expect economic growth to accelerate in the second half the year, driven by domestic demand. However, the latest data suggests that risks are skewed to the downside, pointing towards GDP growth of 3% this year. Fitch revised Serbia's sovereign rating to BB+ from BB and kept a stable outlook. The rating upgrade reflects maintained fiscal discipline, preserved price stability, decreasing public debt, continuous improvement in credit fundamentals of the banking sector and improvement of the business environment. We remain overweight in local and hard currency bonds.
Turkish assets gained as interest rates were cut by less than the market had feared, as we mentioned in the Market review. Coupled with the a relatively reserved accompanying statement from the central bank, this was viewed as a positive sign for central bank credibility, inflation and economic stability. However, we remain cautiously positioned. Recent changes to key personnel at the central bank has put a question mark over the extent of its independence. And as for broader economic policy, at the time of writing the government had just announced an ambitious growth plan which simply does not add up, in our view.
In Russia, the central bank cut rates early in the month as expected. With soft inflation data and growth on fragile footing, we expect continued pressure to ease rates, which explains our overweight positioning in local currency bonds. Russia’s strong fiscal and balance of payments dynamics also lead us to be overweight the ruble and hard currency sovereign bonds. And while a protest in Moscow hit the headlines, it was relatively muted and non-violent in nature.
The election at the end of August of a market-friendly prime minister is among the factors explaining foreign investor interest in Ukraine’s local currency bonds, as reflected in the strong take-up of a major government bond auction. The country’s decent inflation outlook and anti-corruption moves by the new president all add up to a positive story. That said, the IMF has asked for more clarity on the 2020 budget and is watching closely a legal battle around a recently nationalised bank that is at the centre of a corruption controversy. S&P upgraded the country’s credit rating and Fitch changed its outlook to positive. We are overweight hard currency (dollar) bonds and we hold an unhedged position in the country’s local currency bonds.
In our blended strategy we cut our overweight exposure to Israel towards the end of the month having benefited from the strong rally. The market reacted positivitly to political developments which suggested the country may avoid a further swing to the far right. Inflation dynamics also remain supportive for bonds.
In South Africa a Moody’s rating downgrade or outlook change is looking less likely for this year, given more positive words from the rating agency and the fact that a delay in the country’s Medium Term Budget Policy Statement will leave little time for this anyway. The central bank kept rates on hold as expected, but the unanimous vote for this was somewhat surprising. While positive for inflation stability and currency strength, a more hawkish central bank equates to a lack of monetary policy stimulus for the economy. Like Russia, South Africa’s central bank appears to be learning from others’ mistakes in keeping back some ammunition in case things get really tough in the global economy. We remain overweight local bonds, which we believe are priced attractively given the low-growth and weak inflationary backdrop. We are also still underweight both the currency and sovereign bonds.
In the Middle East, the attack on a major oil facility in Saudi Arabia dominated headlines in September, as mentioned in the Market review. We remain underweight Saudi Arabia and overweight Qatar.
Among the region’s high-yield bond markets, we remain overweight the long-end of Jordan’s debt market and overweight Oman; we are underweight other markets, including Lebanon. Lebanon remains a structurally challenged bond market given high fiscal and current account deficits, coupled with a difficult political backdrop.