We started 2024 with a constructive outlook on emerging market (EM) hard currency debt. In recent years, risk assets including EM debt had been impacted by a range of significant shocks, including Covid-19, the Chinese real estate crisis and the war in Ukraine, along with high inflation and a sharp hiking cycle from global central banks. We expected that a gradual easing of many of these headwinds would improve investor sentiment, with EM fundamentals and local stories becoming key market drivers once again. Credit spreads were relatively tight at the start of the year; while we did not expect to see significant spread compression, we thought that we would be able to capture the elevated yields on offer.

EM hard currency debt performed well in the first half of 2024, particularly corporate bonds. The first half of the year was generally a carry environment for EM corporate debt, though there was also some marginal tightening in credit spreads which offset some of the renewed volatility in US Treasuries.

Rates: Constructive outlook but expect high volatility

Looking ahead to the rest of 2024 and into 2025, we remain cautiously optimistic about the rate backdrop. While rate volatility remains elevated on a historical basis, and uncertainty over fiscal plans can add some additional term premium, we believe it is unlikely that US Treasury yields will reach the peak we saw in 2023. Recent data has increased confidence that the rise in US inflation in the first quarter was mostly a short-term hiccup; nevertheless, we prefer to avoid taking a stronger active bias on rates, instead maintaining a relatively neutral stance on duration.

China: Limited risk of contagion

China remains a key driver of investor sentiment towards broader emerging markets. There were some modest improvements in China’s macroeconomic data in the first quarter, though there is still some uncertainty in the real estate sector, and overall fundamentals for housing remain quite weak. Government support measures, including new incentives for local governments to acquire unused properties, have been important in reviving market sentiment.

We view China as predominately policy driven; given ongoing uncertainty around policy, we choose to avoid having major exposure to China or to its real estate sector. Valuations outside of the real estate sector still look tight, and we have seen a substantial rally in some high yield names since the beginning of the year (albeit from very depressed levels, and often being liquidity driven). Overall, we continue to see a more constructive environment for EM broadly speaking, and we think China’s issues remain relatively contained, without too much risk of contagion across EM.

Record number of elections

At the start of 2024, we also noted the importance of a record number of elections being held this year. As is often the case, year to date, elections have already brought some surprises. For example, Mexico saw a stronger-than-expected victory for the Morena party, raising fears about more radical reforms in the coming years. Elsewhere, India and South Africa saw a lower margin win for their incumbent parties, leading to concerns about falls in overall political stability in both countries.

We do not believe that these election results change overall fundamental stories in emerging markets. However, we have made some adjustments to our positioning as a result, particularly in Latin America, where we have reduced our allocation to Mexico, primarily in areas that we think could be more vulnerable to more radical policies (e.g. the financials sector).

Looking ahead, the US election remains a significant unknown, the result of which will likely impact both developed and emerging markets. Tariffs and their resulting effects on some EM exporters are key factors to watch, along with their potential geopolitical repercussions.

Focus will return to EM fundamentals

Against this backdrop, we still believe EM fundamentals will become key drivers again. Balance sheets for EM corporates remain fairly healthy, with the increased cost of debt having caused only marginal deterioration. The resilience of EM corporates shows how mature they have become overall. In many regions, additional funding options offered by local markets have been important (in some cases being even cheaper than external markets), providing companies with additional flexibility when managing their capital structure.

In terms of sovereigns, we continue to see good progress being made on many key restructurings.

Spreads look relatively rich from a historical perspective, but given the fundamental picture and the resilience of economic growth across the globe, we believe these levels can be justified. Given the increase in US Treasury yields since the beginning of the year, EM debt yields are now also back at the same level as they were at the start of 2024 (or higher for sovereign debt). We continue to believe we are in a good environment to harvest carry as we progress through the second half of 2024.