2020 was a volatile year for emerging markets (EM). EM debt faced underperformance during the first half of the year, a sharp retracement and outperformance relative to developed markets during the early summer, and subsequent bouts of intermittent rallies and sell-offs through October. The US presidential election result combined with positive news on vaccine developments were important catalysts to help generate an upswing in November.

In this paper, we look at the four factors that are likely to drive EM debt markets in 2021:

1.  The path of the virus

2. The global macro environment 

3. EM Fundamentals 

4. Politics 

While issues of rising debt burdens and inflation are key areas of focus, we believe that attractive valuations in an environment of a developed market growth recovery, ongoing fiscal monetary and fiscal stimulus and less aggressive geopolitics should provide a solid backdrop for EM debt. 

1.  The path of the virus

The vaccine announcements in November provided a boost for EM risk sentiment. The use of effective vaccines significantly reduces the risk of economies having to go in and out of restrictions for another year, paving the way for a return to economic normality during 2021.

Daily confirmed cases of COVID-19

 

As at 26 November 2020. Source: https://ourworldindata.org. 

 

While the cost, storage and distribution of vaccines could be a challenge for some EM countries, depending on the wealth of countries and effectiveness of governments, several factors increase the likelihood that EMs will have access to vaccines sometime in 2021: (1) there are a number of vaccine announcements coming at once; (2) the efficacy is much higher than expected, which suggests more vaccines will be developed, more local to where they are needed; and (3) the transportation and storage options being wide ranging, which improves accessibility, especially for poorer countries. Even for those countries that are not able to fully distribute vaccines in 2021, they are still likely to benefit from the recovery in other EM and DM countries.   

In terms of the actual spread of the virus, recent data show a wide variation within EMs. A second wave has appeared in the CE-4 ¹ Latin America and Russia. With EM regions in the southern hemisphere moving into the summer season, the peak of the virus cycle could have passed for many EMs ² China and most of Asia have shown the ability to quickly contain outbreaks. Meanwhile, it is thought that in some countries, or regions, herd immunity has already been reached due to higher levels of contagion but with lower levels of mortality likely due to stronger immune systems, higher exposure to contagious diseases, less comorbidities and younger populations in EM countries.

2. The global macro environment 

DM monetary policy: Liquidity, boosted by ongoing accommodative central bank policy, forms a good backdrop for EM debt. The Federal Reserve’s (Fed) new policy framework suggests a tolerance for inflation to overshoot before it will hike policy rates, signalling that its monetary policy could remain easy for years to come. The fact that EM bonds are one of the few markets to still offer decent yields across global fixed income, combined with the fact that EM bonds have generally been under-owned, should be supportive of flows in the coming year, both for EM hard currency and local bonds.

DM fiscal stimulus: DM countries entered 2020 with high sovereign debt following the global financial crisis. Austerity was attempted for a decade to reduce debt, but it failed and there is now no political will or public appetite for more austerity as a path forward anywhere. Fiscal stimulus now needs to be of a large-scale, meaningful nature – which means state-sponsored infrastructure spending. This augers well for EM countries as they house a lot of the resources needed for that infrastructure spend. While there are risks around DM debt sustainability, in the short to medium term it remains bullish for assets and helps EMs with access to capital and lower refinancing costs via the demand for yield.

 

1. CE-4 refers to the Czech Republic, Hungary, Poland, and the Slovak Republic.

2. As at 26 November 2020, Source: https://ourworldindata.org

 

• 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.
• Depending on the strategy, risks may be associated with investing in fixed income, derivatives, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.