Andrea Iannelli, investment director, Fidelity International, discusses why the team remains bullish on emerging market debt (EMD).
”We maintain our bullish stance on EMD given the tailwinds that support our thesis continue to play out.
As growth expectations have slowed, the US Federal Reserve has been quick to change its tune, despite a tight labour market and rising wage pressures. The increased likelihood of more stable US interest rates and a halt to the balance sheet unwind should put a floor on EM assets by allowing for easier EM central bank policy. The key is whether the Fed can engineer a “sweet spot” economic landing at around-trend growth - not too hot, not too cold.
The lowering of US growth expectations has typically been supportive for EM currencies against the dollar, although February saw a pause in the EMFX rally witnessed at the start of the year. Nevertheless, we remain constructive on EM currencies in aggregate as we believe the US dollar peak is behind us. Our view is predicated on growth and interest rate differentials between the US and the rest of the world starting to narrow, widening twin deficits in the US, and the Dollar’s expensiveness on a trade-weighted basis. With the US dollar and US real yields likely to have both peaked in this cycle, we expect positive EM returns will be sustainable for the coming months, particularly in hard currency assets.
The EM growth swoon last year was in part due to China’s ongoing economic moderation, damaged by a weak consumer and a slowing credit impulse. This year, we expect domestically-oriented policy responses to pick up both on the monetary and fiscal side as authorities prioritise growth stabilisation and temporarily de-prioritise deleveraging. Monetary policy across the rest of the world is also expected to be dovish. Several EM countries have now elevated real policy rates, falling inflation expectations and wide output gaps. If our thesis around a weaker US dollar holds true, countries such as Turkey, Mexico, Indonesia and South Africa among others may look to unwind the rate hikes from last year and ease financial conditions. If done in a responsible manner, this should be supportive for local currency bonds and not a major obstacle for EM currencies.
After last year’s hectic election cycle, this year is shaping up to be the year of political continuity for many EM countries. Incumbents are likely to extend their mandates and maintain current policy trajectory, heralding political continuity into 2020. This is a marked change to 2018 which witnessed volatile regime change in several countries which during the election campaigns unnerved anxious investors (e.g. Brazil and Mexico).
“Positive signs on the US-China trade talks and potential for further domestic stimulus has made us more positive on Chinese corporate bonds. Outside of this, we like some single-B sovereigns with IMF support, notably; Argentina, Ukraine and Ecuador.
On the local currency side, we like countries with the potential for rates cuts, with steep curve or with generous real yields, such as in Mexico, Colombia, Peru, South Africa, Serbia and Indonesia.
In EMFX, we like several Latin American currencies such as Argentina, Peru, Chile and Colombia. Outside of Latin America, some markets like Hungary and Malaysia remain attractive. We also have some carefully sized positions in frontier local currency markets such as Ghana, Dominican Republic and Nigeria.”
Fidelity International is responsible for £75.9 billion in assets under administration.
Fundeye highlighted an EMD fund earlier this year with its top holding being Argentinian sovereign bonds in hard currency. Read about it here
