The Effect of US Elections on Emerging Market Sovereign Bonds
Emerging markets proved resilient in 2024. High yield sovereigns in Africa and Latin America led the way. Given the depth of the rally and potential volatility around the US election, we began reducing exposure to a selection of high yield and investment grade securities.
Who won and who lost in the first half of the year
Among the salient facts of the first half of the year, it is worth mentioning the outperformance of dollar-denominated emerging market sovereign bonds (2.3%) compared to those in local currency (-3.7%), as the latter were affected by the strength of the dollar. It should also be noted the outperformance of emerging market high yield sovereign bondsup 5.2%, with “single B” bonds up 4.9% and “distressed (C)” bonds up 21.5%. This compares with a return of -0.5% for investment grade emerging market sovereign bonds. This outperformance of the high yield sector reflects macroeconomic stability, thanks to fiscal consolidation in some countries, financial support from the IMF, the flow of foreign direct investment (FDI) and progress in debt restructurings. However, investment grade assets have started to outperform the high yield sector, following the rally in US rates. Finally, it should be noted the regional outperformance of Africa (+6.3%) and Latin America (+2.4%). Among the countries that have outperformed the S&P 500 (14.5%), we mention Ecuador (+45.7%), Argentina (+30.9%), Zambia (+23.1%), Egypt (+20.4%), Ghana (+16.7%) and Bolivia (+16.3%).
The outlook for the second half of the year
In the short term, the market is likely to continue to be driven by expectations for US monetary policy. Further election-related uncertainty would likely increase market volatility leading up to the November 5 election and possibly beyond. Looking ahead, global growth forecasts for 2024 appear broadly in line with the previous year’s (2023) forecast of 3.2%. In particular, The economic growth gap between emerging markets and developed markets is expected to reach its widest level in nearly a decadeas some large developed economies slow down or struggle to recover.
In addition, more prudent macroeconomic policies have emerged, characterized by conservative fiscal management, a gradual reduction in subsidies and a growing commitment to monetary orthodoxy through inflation targeting. As a result, We do not expect any sovereign defaults in 2024 and 2025. In fact, 73% of emerging market rating actions this year have been upgrades or shifts to a positive outlook.
Opportunities on the market
On the valuation side, while credit spreads are at the tighter end of historical ranges, we are finding value in various market segments. We are taking advantage of opportunities offered by various themes, including improved fiscal dynamics, favorable demographic factors, demand for raw materials and increased regionalization of trade.
In our emerging markets hard currency portfolioswe have reduced overweights to a selection of frontier sovereigns, for which further appreciation will have to depend on external factors, while we have started to increase exposure to investment grade sovereign bonds.
In our local currency portfolios, however, we are favoring countries with idiosyncratic drivers (such as Egypt, Turkey, Nigeria) compared to exposures that are more dependent on US rate policy or a general reduction in volatility.
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