Head - Fixed Income Strategy
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We outline some of the challenges EM bonds will face in the coming year.
As we look to the coming year, valuations in global emerging markets look much different than 12 months ago. While we would not classify EM bonds as overly cheap, spreads and yields have largely discounted many known risks. Still, elevated volatility should be expected and will likely remain a challenge to benchmark performance over the coming year.
Some challenges include:
Our outlook on external EM spreads will be largely contingent on the outcomes of the above risks. However, there are other positive signals to consider. Firstly, the US growth outlook may be slowing, but leading indicators suggests the aging expansion should continue. This should keep the Fed from altering their historically slow tightening cycle. Secondly, previous China policy easing is beginning to have a positive impact on their growth cycle, while further stimulus is expected. Thirdly, positive earnings growth and cheaper valuations favors a rebound in equities. As such, improvements in risk appetites may fuel flows back into EM markets.
That said, we believe EM debt is poised to modestly outperform over the coming year. Even if sovereign EM spreads end 2019 unchanged, this would imply an expected total return between 3-4%. While low single digit returns may be unappealing, consider that this may come in an environment where global aggregate fixed income benchmarks struggle to produce positive returns.
As such, we continue to hold a slight overweight in EM debt in our global asset allocation framework (both external and local debt).