Market review

In October, hard-currency emerging market debt (EMD) (1) returned -1.35%, while local-currency EMD (2)  returned -0.53%. In emerging markets corporate debt (3), the total return over the month was -1.22%.

In hard-currency EMD, there was a negative impact from US Treasury yields, as the 10-year US Treasury yield rose by 36 basis points (bps) to 4.93%, after briefly hitting over 5% for the first time since 2007. However, there was a positive contribution from spreads, which widened by 5bps in October. The US economy remains resilient, with recent data coming in better than expected. Third-quarter GDP growth of 4.9% (quarter on quarter), versus the predicted 4.5%, was the fastest annualised rate in two years. Outside the US, the month’s biggest news story was the attack by Hamas on Israel on 7 October. Investors became increasingly concerned about geopolitical risks and the potential for a broader escalation. As a result, assets in the region were adversely affected and investors flocked to safe-haven assets such as gold.

In local-currency EMD, foreign-exchange returns (-0.66%) weighed on sentiment, as the US dollar appreciated for a third consecutive month against a basket of major currencies. Conversely, local EM bonds (0.13%) boosted performance in October. In EM corporate debt, rising Treasury yields and the widening of spreads negatively affected overall returns.

Outlook

EMD markets weakened for a third consecutive month in October. Spreads remain well below the level seen during the US regional banking crisis earlier this year, as investors continue to hope for an economic ‘soft landing’. Nevertheless, headwinds remain for EMD, with the persistently strong US dollar, driven by higher US policy rates, and narrowing rate differentials creating a challenging environment for EM central banks. Higher energy prices can stress the balance of payments for net energy importers, which could also hamper progress on inflation for those economies where energy-driven components constitute a large portion of the consumption basket.

The ‘Goldilocks’ scenario for EMD would combine the current expected path for US interest rates with the avoidance of an outright recession and a weaker US dollar. However, higher US interest-rate expectations and increasing financial stability risks could dampen investor sentiment and lead to more ‘risk-off’ conditions.

We continue to add duration due to attractive yields, but we remain cautious where countries have challenging amortisation schedules with a significant need for market access, given the higher cost of financing. Additionally, we anticipate continued support from multilaterals and progress to be made on several restructurings following the International Monetary Fund and World Bank meetings.

(1)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)

(3)As measured by the JP Morgan CEMBI Broad Diversified Index