Market reviewIn August 2022, hard-currency emerging market debt1 returned -0.95%, while local-currency emerging market debt2 returned -0.14%. On a year-to-date basis, hard-currency emerging market debt has returned -18.78%, while local-currency emerging market debt has returned -14.40%.
The rally in emerging market bonds that was seen throughout July continued into the first half of August, as a slightly softer-than-expected consumer price index (CPI) print in the US boosted market sentiment, with investors showing some relief at the possibility of a more dovish US Federal Reserve (Fed). However, the rally proved short-lived, as policymakers were out in force in the week leading up to the global central banking conference in Jackson Hole, Wyoming, indicating that they were far from finished in terms of their monetary tightening activity.
In the case of hard-currency emerging market debt, the biggest negative driver was a significant increase in US Treasury yields, with the 10-year yield rising by 54 basis points (bps) to 3.19% by the end of August. As such, the negative impact of this dominated the positive impact from spreads on the JP Morgan EMBI Global Diversified Index tightening by 31bps to 502bps over Treasuries. In the case of local-currency debt, the small negative return for the month reflected the dominant impact of negative emerging market currency movements over the month, which exceeded the positive contribution from bond prices. In the commodity space, Brent crude fell by a sizeable 12.3% to US$96.40 per barrel over the month, as the market continued adjusting for a less favourable global growth outlook.
OutlookWhile the outlook remains challenging across risk assets, we are seeing pockets of value opening up in certain areas of emerging market debt. We saw a flurry of IMF agreements in August, as governments altered course to gain access to much-needed funding. Sri Lanka and Zambia were the most recent examples. The Zambia case is particularly notable as it is one of the three nations that requested funding under the so-called ‘common framework’. Beset by delays due to key creditor China's unwillingness to participate in discussions and a lack of clarity as to how the framework should actually be implemented, it's good to finally see some progress on this front. Generally, this is also a positive development for other countries in need of support, as well as for international bondholders.
We believe inflation should decelerate towards the end of the year. This should enable an end to rate-tightening cycles in many emerging markets, given the peaking of global food and energy prices three months ago. Brazil is one name that we feel is leading the way in this regard. We expect the volatility that we have seen throughout the first half of the year in emerging market debt to persist, as developed markets have entered a period of quite aggressive policy tightening. Therefore, we think a highly selective investing approach remains sensible at the present time.
Footnotes1 As measured by the JP Morgan EMBI Global Diversified index
2 As measured by the JP Morgan GBI-EM Global Diversified index (unhedged in US dollar terms)