Local debt: carry offsetting most risks

We expect a positive in move on some local debt curves (Romania, Mexico, Hungary, Poland and India) as their respective Central Banks could continue to cut interest rates in the coming quarters. Romania, Hungary, Poland and India are all benefiting from sizeable imports of cheaper commodities. On the other hand, we have negative biases on Czech, Malaysian and Philippine debt, given the low level of their carry. For the latter two, rate hikes are not to be excluded in the coming months.

External debt: attractive in a low-yield context

Like local debt, external debt is displaying attractive features, with a spread versus US Treasuries currently at 360 bps, offsetting, in our view, the risk of a gradual normalisation of the US rate environment. We expect about 70 bps of spread-tightening for the asset class before year-end. Emerging country fundamentals are overall sound (robust growth data & a low debt/GDP ratio), albeit less rosy than during the last 5 years.

Technical factors are also positive drivers. Firstly, flows should again be positive this year, keeping to the trend of H2 2014. Secondly, the lack of net new supply (i.e., new issues minus redemptions) will trigger a search for attractive risk/return issues. This phenomenon should result in tighter spreads.

Forex: cautiousness towards oil currencies

We favour currencies with good reform momentum. In the case of the INR, the reforms in India are still on-going and have started to bear fruit. Although the currency has firmed up in recent months, there is still room in the reversal trend for a large retracement.

On the “overweight” side, we also favour the KRW. This low-beta currency is a nice-to-have in cases of risk aversion due to the solid fundamentals of South Korea (strong current account and high FX reserves). The main risk factor identified for this currency is the recent sharp depreciation of the yen as Japan is a serious economic competitor. We also like the CNY, as we consider that the depreciating trend of this PBOC-managed currency has come to an end. Similarly, it is also a low-beta currency and the country is still enjoying a large current-account surplus.

We are keeping a sizeable pocket of USD as both risk aversion and expectations of a rate-normalisation process in the US should further support the USD. Besides, the sell-off on commodities has weakened oil exporters and thus could lead to a softening of their monetary policy in order to preserve their competitiveness. Because of this, we remain underweight on commodity-linked currencies such as the RUB, the NGN and the PEN. We have also underweighted the ZAR: the country is facing stagflation (high inflation and weak growth data), and this could be very painful for the currency.