Capital IdeasTM

Investment insights from Capital Group

Categories
Fixed Income
Emerging markets debt: Starting yields lift return potential

Emerging markets bonds notched solid gains during the first quarter. Global market conditions became more uncertain as shocks across the US and European banking sectors raised concerns that hawkish central bank policies could spark another financial crisis. That said, emerging markets bonds held up well as investors focused on the macro tailwinds from China reopening alongside relatively strong fundamentals and high starting yield.


Local currency denominated bonds benefited from foreign exchange currency gains, with notable strength coming from Latin American currencies.  A rally in bond prices likewise contributed to positive results during the quarter.   


Investment-grade hard currency sovereign bonds outpaced their high yield counterparts during the quarter, with both credit quality cohorts posting gains. From a regional perspective, Asian credits saw the sharpest gains, while Africa was the sole region to close in negative territory. 


Though broad market uncertainty is likely to persist, our overall outlook for emerging markets debt remains cautiously constructive. We favour a tilt toward local currency markets, particularly across Latin America, where a rollover in inflation coupled with expected policy easing will likely provide attractive total return opportunities. We also believe that emerging markets currencies are well positioned to deliver positive returns relative to the dollar due to undervalued exchange rates and the Fed’s anticipated pivot away from additional policy tightening later this year.


High yield EM hard currency spreads volatile on uncertainty

High yield EM hard currency spreads volatile on uncertainty

As at 31 March 2023. IG: investment-grade. HY: high yield. IG EM and HY EM are components of JPMorgan EMBI Global Diversified Index. Source: JPMorgan

Opportunities within the dollar denominated sovereign space tend to be more idiosyncratic. We find select distressed and quasi-distressed issuers attractive. Debt restructurings across this segment of the market are high but likely to be contained to the most vulnerable countries. Though valuations are less attractive across investment-grade sovereign bonds, we find value in owning select lower beta credits as a counterbalance to the high yield positions held across portfolios. 


Off-benchmark allocations to EM corporate bonds are currently larger than historical averages, based on healthy fundamentals and the potential for spread compression. 


Latin American currencies have led recent FX gains

Latin American currencies have led recent FX gains

As at 31 March 2023. Returns reflect the foreign exchange (FX) returns for the JPMorgan GBI-EM Global Diversified Index regions unhedged in US dollars. EMEA: Europe, Middle East, and Africa. Source: JPMorgan


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.