Easing stance of CBs should support local rates

In our opinion, the Emerging Market debt denominated in local currencies is one of the most attractive Fixed Income asset class with a yield at currently 6.5%.

We consider that, at this level, it offset the currency and duration in risks, even in a volatile context. Many Emerging countries are facing lower prices due to poorer commodities prices or weak domestic demand. As a result, it gives more incentives for EM central banks to adopt more accommodative stances by cutting refinancing rates. It could bring support for local rates. In particular, we continue to remain exposed to countries like Indonesia and Russia where we expect rate cuts given the weak growth expectations.

However, we remain cautious on local debts from commodity exporters like Peru, Colombia and Malaysia and countries whose Central Banks are in hiking rate mood (South Africa, Brazil).

Appealing risk/return features of external debt

The external debt displays attractive features with a spread versus US Treasuries currently back at 340 bps. In a low yield environment, we consider this spike in spread as a good buying opportunity given the attractive risk/return features (Chart 6). We expect spreads to tighten to 300 bps by year-end, on the back of solid fundamentals and supportive debt profiles. Technical factors are also positive drivers. Flows should continue to enter the asset class as it did in S1. The lack of net new supply (i.e., new issues minus redemptions) is also highly supportive.

We maintain an overweight on Indonesia and Morocco which are attractive in our view in the Investment Grade space with positive reform momentum.

We acknowledge the Greek contagion spread to Eastern Europan debts. Even though many of these countries have limited commercial relationships with Greece, the risk-off environment negatively impacted these debts in a broadly undifferentiated manner. On a long term horizon, we do not see sustainable economic impact on these contries and are expecting a spread tightening when an acceptable political solution will be reached.

A defensive stance on local currencies

We still have a negative view on emerging currencies overall as we expect a US dollar strengthening driven by a hawkish monetary tone.

Our current cautious stance on emerging currencies is translated by a long positioning on USD. We also switched to a defensive positioning on Mexican peso. The currency is one of the most used proxy by market participants to hedge their Emerging Forex risk (as it is one of the most liquid). We remain notably negative on ZAR given the weak growth and twin deficit and RUB given the lack of reform momentum, recession and expected rate cuts.

On the “overweight” side we like the CNY, as we consider that the depreciation trend of this PBOC-managed currency has come to an end. CNY is also a low-beta currency and the country is still enjoying a large current-account surplus.