Pockets of opportunity in emerging-market debt
Emerging market (EM) local-currency sovereign bonds put in a good performance in 2020, with the JP Morgan GBI-EM Global Diversified index making a total local-currency return of 8.4%. However, this turns into only 2.9% once converted into US dollars because EM currencies depreciated strongly against the greenback during the market turmoil of H1 2020 and regained only part of their losses in H2.
The two main contributors to the fall in EM sovereign yields from 5.2% at the start of January 2020 to 4.3% on 8 January 2021 were the inclusion of Chinese government bonds on the GBI-EM index and EM central banks’ policy rate cuts. However, the rate-cutting cycle is nearing its end and rates could go higher in some countries (rate cuts have already gone into reverse in Turkey, and Brazil could follow).
We expect a slight turnaround in EM local-currency sovereign yields, which could rise towards 4.7% by the end of 2020. This forecast is underpinned by our expectations of potentially more policy rate hikes than cuts in the EM complex and the possibility of idiosyncratic risks (re)-surfacing in some large EM countries. Nevertheless, coupled with relatively high yields, further EM currency appreciation versus the US dollar could ensure a comfortable single-digit performance. As such, we are neutral on EM local-currency sovereign bonds entering into 2021.
EM corporate bonds in US dollars performed well in 2020, with the JP Morgan CEMBI Diversified index’s 7.3% total return driven by tighter credit spreads (after the peak of 616 bps reached on 23 March) and the strong performance of US Treasuries. EM corporate high yield experienced fewer defaults than its US counterparts. Moreover, EM corporates’ net leverage ratio is lower, making spread per turn of leverage more attractive for EM investment-grade and high-yield bonds alike.
We expect a positive single-digit performance in 2021 from EM corporate bonds thanks to additional credit spread tightening and relatively high yields. We have thus moved to overweight on EM corporate bonds for 2021, with several attractive investment themes coming to the fore as we start the year.