Emerging market debt: the rally is not over yet

Bonds
Althea Spinozzi

Fixed Income Strategist

Summary:  Emerging markets will continue to offer exciting opportunities next year as investors are pushed towards higher-yielding securities amid a rise of negative-yielding debt. Hard currency EM bonds will be supported by dovish policies from the Federal Reserve and the ECB. We will most likely see EM countries refinancing and extending debt maturities with 100-year bonds becoming a more popular source of funding.


As we get closer to the end of 2020, investors start to make the sum of what we can call a unique year. With the Covid-19 pandemic, volatility picked up substantially. Although many assets are still on the way to recovery, some have rebounded sensibly. Emerging market bonds have experienced an exceptional rebound, which is making many wondering whether they can continue to rise.

There are several reasons why we are bullish emerging markets .

First of all, the Federal Reserve will not hike interest rates until it sees a rebound in inflation. This means that investors will be pushed to search for solid returns outside their comfort zone. It also implies that if interest rates don't rise, emerging markets will be able to continue to finance themselves conveniently.

Emerging markets' constant need for financing is a point that is worrying investors as they become more and more dependent on capital markets. We don't believe this to be a significant problem. EMs have just gotten the green light by the IMF to engage in expansionary monetary policies which, in return, will ultimately support their fixed income market value. Secondly, even though the Covid-19 pandemic has added pressure to certain geographies and sectors, in 2020, the market has seen EM debt maturities getting longer, not shorter. This is a positive trend because it means that countries can lock in low interest rates for longer, decreasing refinancing risk in the short- and mid-term. One of the best examples is the one of Turkey, which was able to extend maturities in both dollar and lira debt even amid a currency crisis. Peru, similarly, issued $4 billion bonds this week with 12-, 40- and 100-year maturities. Peru's 100-year bonds priced at 170 basis points over the Treasuries, making it the lowest-yielding century bond in the emerging market world.

The engaging of accommodative monetary policies by developed central banks are also having a positive effect on emerging market debt. As the graph below shows, EM hard currency sovereign debt has performed better compared to EM local currency government debt. This trend can be explained by the expansionary policies that the Federal Reserve and the ECB engaged in following the Covid-19 pandemic, which pushed yields down across all assets. As central banks worldwide continue to add stimulus, we can expect these assets to continue to be supported.

Interestingly, following the pandemic, better quality EM assets experienced a more significant rebound compared to junk. Before Covid-19, high-yield EM debt performed better compared to investment-grade EM debt. This might be a sign that riskier assets remain undervalued.

As indicated in our earlier analysis of the emerging markets, it is crucial to pick risk selectively as some countries might be overleveraged. In our Emerging market distress monitor (below), we find that Russia, Indonesia, Mexico and the Czech Republic are the countries that offer stable market conditions. Turkey, Argentina, Egypt, Angola and Chile, on the other hand, look to be the riskiest. The monitory compares debt to GDP ratio of each country with their 5-year CDS spread and money supply.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
- Full disclaimer (https://www.home.saxo/en-mena/legal/disclaimer/saxo-disclaimer)


Due to coronavirus controls, with many of our staff working from home, we are not able to meet with clients in our reception at present, unless by appointment in exceptional circumstances. We remain at your service on the phone and email details below. Thank you for your understanding.

*Please expect very long waiting times on the line when calling us, we advise you to send us an email instead.

Contact Saxo

Select region

UAE
UAE

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

Saxo Bank A/S is licensed by the Danish Financial Supervisory Authority and operates in the UAE under a representative office license issued by the Central bank of the UAE.

The content and material made available on this website and the linked sites are provided by Saxo Bank A/S. It is the sole responsibility of the recipient to ascertain the terms of and comply with any local laws or regulation to which they are subject.

The UAE Representative Office of Saxo Bank A/S markets the Saxo Bank A/S trading platform and the products offered by Saxo Bank A/S.