Fixed Income
Fixed Income Q&A: macro risks vs opportunities in EM
Peter Becker
Investment Director
Luis Freitas De Oliveira
Portfolio Manager
  • While the Federal Reserve’s patient tapering schedule suggests inflation is having only a limited impact on US monetary policy, some developing countries have reacted strongly to inflation as a threat to economic stability.
  • A slowdown in China is likely heading into 2022, with falling demand for commodities expected to have an impact on some emerging markets.
  • Emerging market debt offers select opportunities in local currency bonds, however a focus on growth divergences across countries is vital.

With the return to growth since the onset of the COVID-19 pandemic, what opportunities can be expected for a sustained recovery across the global economy and emerging markets?

A scenario where the global economy emerges stronger post COVID-19 is quite plausible based on a combination of factors coming to the fore. The acceleration of digitalisation, alongside enduring policy support, are two key areas that have produced favourable conditions for growth and raised expectations for future corporate profits, particularly in the US, and in other economies to a lesser extent. Much of these forecast gains have been priced in and while we're open to the possibility of these earnings being realised, there are a number of structural headwinds to bear in mind.

The first of these is a long tail of low productivity firms expected to weigh on the overall growth trend. Looking to emerging markets specifically, we see a moderation in demographic forces that have driven a very positive growth story across many developing countries in the last 20 years. Looking towards the next 20 years, the rate of expansion in youth populations and participation rates is slowing, creating another headwind that could dampen growth in emerging markets.

On balance we would expect this expansive post COVID-19 growth era to be relatively brief and be followed by a transition to a stable, more sustained recovery owing to these significant structural headwinds.

As inflationary pressures gather and governments respond, is this macro theme likely to become a cause for concern for fixed income investors?

In responding to the widespread economic disruption of the pandemic, many central banks have loosened monetary policy to a degree. However, these measures have been far from uniform across the globe, with many major central banks in the developed world, particularly the US Federal Reserve (the Fed), altering their strategy to manage economic development in a number of important ways.

Firstly, they’re more likely to respond to inflation outcomes rather than to inflation forecasts. This results in central banks essentially becoming more behind the curve. They’re also placing a far greater emphasis on providing favourable financing conditions as a key stimulus measure for economic activity. The pandemic has also heightened concerns from leaders in developed countries about inequality within their borders, further influencing the economic policy agenda.

With all these factors combined, there is a strong tendency for central banks to keep the scales tilted towards stimulus, placing more weight on unemployment and growth outcomes over inflation concerns. If this policy stance were to continue, with central banks looking at growth factors rather than inflation outcomes to determine their path forward, this would contribute to our view that actual inflation could overshoot forecasts in the near-term.

However, the markets’ apprehension regarding the strength of these inflationary pressures could lead the Fed to take a less patient approach. From announcements made late in Q3, the Fed appears to be aligned with our view that the inflation spike will be short-lived. Recent price increases are mainly being triggered by supply chain disruption and the surge in demand for some goods and services as economies have opened up. As the chart below suggests, this kind of inflation tends to be transient; we believe it is likely to stabilise later next year and subside as we head into 2023 and 2024. Over the medium term, however, the risk remains that a continued and disruptive inflation situation could force the hand of the Fed.

A tale of two- inflations: sticky versus flexible

Sticky and flexible price inflation, YoY change (%)

Data as at August 2021. Sources: Federal Reserve Bank of Atlanta; Refinitive Datastream
Sticky and flexible prices reflect the Atlanta Federal Reserve sticky and flexible consumer price indexes (CPI). If price changes for a particular CPI component occur less than every 4.3 months, that component is a “sticky-price” good. Goods that change prices more frequently are “flexible-price” goods.


Risk factors you should consider before investing:
  • This material is not intended to provide investment advice or be considered a personal recommendation.
  • The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
  • Past results are not a guide to future results.
  • If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
  • Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.

Peter Becker is an investment director at Capital Group. He has 26 years of industry experience and has been with Capital Group for four years. Prior to joining Capital, Peter was a managing director in the fixed income product management team at Wellington Management. Before that, he was a portfolio manager at Aberdeen Asset Management. He holds a master's degree from The Ingolstadt School of Management. He also holds the Chartered Financial Analyst® designation. Peter is based in London.

Luis Freitas de Oliveira is a portfolio manager at Capital Group. He is chair of Capital International Sàrl. He has 33 years of investment experience and has been with Capital Group for 28 years. He holds an MBA from INSEAD, France, and a bachelor’s degree in economics from the Federal University of Minas Gerais, Brazil. Luis is based in Geneva.

Past results are not a guarantee of future results. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.