Capital IdeasTM

Investment insights from Capital Group

Categories
Fixed Income
A dovish Fed could unlock opportunity, some caution warranted

Emerging markets (EM) bonds notched significant gains during the fourth quarter, as the Federal Reserve (Fed) struck a more dovish tone on the back of softening economic data. Risk markets rallied on expectations that rate cuts could come earlier than expected in 2024. Both hard- and local-currency-denominated EM bonds benefitted broadly across regions and ratings cohorts from the shift in market sentiment.


Investors have largely priced out recession scenarios

Higher yielding hard currency issuers outpaced their investment-grade-rated counterparts during the period. African high-yield issuers posted some of the strongest gains, as investors favoured the added yield pick-up in these credits despite their elevated risk of default.


Across local-currency-denominated EM sovereign bonds, Latin American and European issuers drove overall results through a combination of price and currency appreciation. Rate differentials between a number of these issuers and US Treasuries remained attractive despite the recent pivot toward rate cuts by several Latin American and peripheral European central banks.


Looking ahead, the somewhat unexpected dovish shift from the Fed in late 2023 should provide a reasonably constructive backdrop for EM debt in 2024. A more accommodative Fed should allow many EM central banks to move monetary policy in a direction that better reflects their domestic outlooks. In most of the core EM economies, inflation is expected to decline throughout 2024, allowing policy rates to come down. 


Inflation in most EMs may continue to decline in 2024

Investors have largely priced out recession scenarios

As at 31 December 2023. Index: JPMorgan GBI-EM Global Diversified index, excluding Argentina and Turkey. YoY: year-over-year. Source: JPMorgan

Falling EM interest rates should provide a duration tailwind for local currency debt holders. To that end, we favour owning local duration in countries where inflationary pressures continue to abate and monetary policies have become more accommodative. Many of these are in Latin America, including Brazil and Mexico, but we are also finding select opportunities across Asia and Africa. We remain more cautious in Central Europe where aggressive easing cycles appear to largely be priced into bonds.


Across EM hard currency debt issuers, the Fed’s dovish tilt should reduce some of the external financing pressures on lower rated frontier economies. We continue to find value in a limited number of these bonds where high yields and reasonably wide spreads provide a cushion against likely volatility and high default risk.


We also find value in some EM corporate dollar issuers where fundamentals are generally good. The geographic representation and risk structure of EM corporates are quite different than sovereigns, and help provide an element of diversification.


Overall, the outlook for EM debt becomes more favourable if the Fed pursues earlier and more aggressive monetary easing than markets initially expected. That said, caution is warranted as EMs may still have to contend with weak global growth, ongoing geopolitical uncertainty and a busy global election year. 



Hear from our investment team.

Sign up now to get industry-leading insights and timely articles delivered to your inbox.

By providing your details you are agreeing to receive emails from Capital Group. All emails include an unsubscribe link and you may opt out at any time. For more information, please read the Capital Group Privacy Policy

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.

Capital Group manages equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.