Emerging markets debt: Volatility calls for patient investors

The rout in emerging markets (EM) bonds continued in the third quarter as global inflationary and negative growth pressures persisted. The ongoing aggressive pace of interest rate hikes from many developed market central banks sparked fears that a global recession may be imminent.

The Bloomberg US Dollar Spot Index, which measures the USD against a broad basket of developed and emerging markets currencies, surged to a nearly 20-year high during the period. The strong US dollar weighed on local currency denominated bonds, which suffered significant losses due primarily to weaker currencies.

Both investment grade and high yield US dollar denominated EM sovereign bonds declined during the quarter. The sell-off was more pronounced in high grade bonds relative to high yield. Regionally, Asian and Latin American issuers saw the steepest losses.

Investor outflows from EM bonds topped US$70 billion year-to-date. Stiffening global economic headwinds, geopolitical uncertainty and growth and policy concerns in China could lead to further outflows.

Valuations across several emerging economies appear to be reasonably cheap and account for many current macro and market-specific challenges. That said, political risks and concerns around policy stability continue to inform our cautious approach to portfolio allocations.

Some central banks that have been aggressive in raising interest rates, largely throughout Latin America, appear to be nearing a policy inflection point as inflationary pressures ease. We remain constructive on local rates markets in some of these countries, including Brazil and Mexico. Given the potential pivot toward more accommodative policies, we also own some duration in these markets.

We believe relative value opportunities slightly favour local currency issuers. Within the hard currency denominated market, high yield sovereigns and select corporate bonds are attractive and provide some diversification benefits to our portfolios. As volatility is likely to persist, managers believe a balanced and risk-prudent approach to investing in emerging markets willbe rewarded once fundamentals reassert themselves. 

Spreads widen as growth prospects weaken 

As at 30/09/2022. IG: investment-grade. STW: spread-to-worst. Credit IG and Credit Non-IG are components of JPMorgan EMBI Global Diversified Index. Sources: JPMorgan, Morgan Markets

Past results are not a guarantee of future results.

Bond yields remain elevated as war and inflation pressures grow

Index through 30/09/2022, and data for the country Turkey is as at 21/09/2022. Yields for country components of JPMorgan GBI-EM Global Diversified. Source: JPMorgan

Past results are not a guarantee of future results.

Quarterly macro and market insights from Capital Group's fixed income team

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