Emerging market bonds generally weakened during 2018, albeit less than some other asset classes. However, economic growth in emerging markets has continued to beat developed market growth, which Hardingham argues leaves EM debt well-placed for the coming year.
“Valuations have improved, and the average EM hard-currency bond yielded more than 6% at October-end,” he said, arguing that many EM currencies traded down in 2018 and may now be undervalued.
By November, for example, the Indonesian rupiah traded at its lowest exchange rate versus the US dollar in over a decade, despite the country’s solid economic outlook.
“Commodity prices, especially the rising price of oil, bolstered EM debt and will continue to be important in 2019. We don’t make long-range commodity forecasts, but some trends are clear. US sanctions on Iran should reduce supply, but China and India will probably continue to buy Iranian oil.
“Valuations have improved, and the average EM hard-currency bond yielded more than 6% at October-end."
“US shale proved less influential than expected because of limited US pipeline capacity. And we expect that Venezuela’s output may continue to decline as long as President Nicolás Maduro remains in place,” he said.
Main stumbling blocks
Liquidity from central banks in developed markets is of course expected to taper off in 2019 and this drop-off is likely to weigh on EM debt.
The US Federal Reserve, meanwhile, projects three rate hikes in 2019. In that scenario, the federal funds target range would rise to 3.00%–3.25%, 100 basis points above its level in November 2018.
“Further trade tensions may weigh on EM sentiment, but we expect their direct impact on EM bonds to be limited,” Hardingham added.
The US Trump administration is likely to continue to focus on its trade deficit with China. China’s local-currency bond market, however, remains small and it’s hard-currency issuers are mainly banks and infrastructure firms that have little involvement with international trade
“Venezuela’s sovereign default, which started in 2017, is likely to drag on as long as President Maduro stays in power, and a regional intervention seems unlikely. Turkey’s currency crisis looks manageable in 2019, given a stronger policy response, with its government less exposed than the country’s corporate sector. Moreover, Turkey’s crisis is country-specific – just like the crises in Venezuela and Argentina – and not symptomatic of wider issues across the EM universe,” he said.
Tracking EM Opportunities
Emerging markets are on course to collectively remain the world economy’s largest segment in 2019, Hardingham said – but this grouping is far from homogenous, and different emerging markets face different challenges.
In Latin America, new Mexican President Andrés Manuel López Obrador (“Amlo”) calmed investors with a market-friendly message before his election in July but has since scrapped plans for a new airport backed by the business community fuelling uncertainty about what kind of president he will be. He was inaugurated on 1 December.
In Brazil, meanwhile, president-elect Jair Bolsonaro has promised to reduce government waste. He is, however, sceptical of Chinese investors and could try to renegotiate Mercosur, the South American trade agreement. He is due to be inaugurated on 1 January.
More elections lie ahead in 2019, for Nigeria (February), Indonesia (April), India (April or May), the Philippines (May), South Africa (by August), Argentina, Uruguay and Mozambique (all in October), and Poland (November).
“But few of these [elections] are likely to be as important as the key presidential elections that took place in 2018,” Hardingham said.
“Indonesia’s economy has thrived under President Joko Widodo, and many investors hope that this will help him see off his main rival, former military commander Prabowo Subianto. In South Africa, voters will get their chance to confirm, or condemn, President Cyril Ramaphosa, possibly against the backdrop of a recession. In Argentina, President Mauricio Macri’s re-election chances have shrunk since he called upon the International Monetary Fund for assistance, but a fragmented opposition may fail to grab power.
“Other than perhaps Lebanon, we see no obvious default candidates among the main sovereign issuers in the year ahead,” Hardingham added.
“After a buoyant 2017, investor expectations for EM debt were high at the beginning of the year. However, 2018 injected a much-needed dose of realism. Now, on the cusp of 2019, we believe prices are more attractive than they have been for a while.”