Gradual normalisation

5 November 2020

Emerging market debt strategy

IN BRIEF

  • Our base case scenario remains a “gradual normalisation,” where the global economy slowly exits recession into 2021. China, which is ahead of the rest of the world in this cycle, continues to lead the recovery.
  • Monetary and fiscal policies are likely to remain accommodative. While we expect the pace of easing to slow, there is ample slack in most economies and policy makers are mindful of tightening too early.
  • Emerging market sovereign investment grade debt recovered relatively quickly and therefore carry will be the main driver of returns. Emerging market sovereign high yield, on the other hand, has plenty of room for spread compression, supporting the case for selective risk-taking.
  • Emerging market corporate investment grade debt has (again) turned out to be more resilient than the rest of the emerging market debt complex, bolstering the view that the asset class is suitable for conservative investors with limited appetite for drawdown risk. Emerging market corporate high yield fundamentals also proved more resilient than expected, suggesting spreads have meaningful room to compress.
  • The prospect of economic recovery, combined with low inflation and accommodative monetary policy, is a supportive backdrop for emerging market local rates. We are also constructive on emerging market currencies as the US dollar is expected to weaken.
  • In the near term, risks are centred on the outcome of the US elections and the implications for global financial conditions. The fundamental tail risks are either an economic double dip, caused by stricter-than-expected lockdown measures mainly in developed markets, or a stronger-than-expected rebound of growth and inflation.

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5 November 2020
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Pierre-Yves Bareau

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