US Exceptionalism and EM Opportunities in Sovereign Bonds
Vikram Aggarwal discusses the recent IMF Spring conference, US economic exceptionalism, progress among distressed EM sovereigns and what it means for investors.
Economists have been forecasting a US recession for the last 18 months. It hasn’t materialised, and the economic data in the US continues to be strong – though employment and inflation has softened recently. The US is powering ahead in terms of economic growth despite restrictive interest rates from the Federal Reserve (Fed).
The IMF raised its projections for 2024 global economic growth to 3.2% in April from the 2.9% forecast in October and nearly doubled its US growth forecast to 2.7% from 1.5%.1 The Wall Street Journal noted that based on IMF projections, the US will account for 26.3% of global GDP this year, the highest in almost two decades.
Growth in EM is more mixed, with China underperforming and India outperforming. The economies of Europe, Australia and New Zealand aren’t matching the US at the moment. Is inflation fading?
Late last year there were expectations of a soft landing or hard landing in the US. Last month, the Fed said that the strong economic data hasn’t given it confidence that inflation is easing. Services inflation, in particular, has been a problem.
Fed rate cut expectations in the marked have been rolled back sharply. On April 30, the 10yr US Treasury yield closed above 5% for the first time since November and has since fallen. But there may be more pain to come.
My view is that the market isn’t fully positioned for the US economic exceptionalism. In December 2023, a Bank of America fund manager survey showed the consensus was for overweight positioning in duration. People are expecting long-end yields to come down. Looking at the data, I am not sure when that will happen.
One of the changes I have made in the sovereign opportunities strategy that I manage is to reduce duration positioning. This is about mitigating the potential for negative performance if the US data continues to surprise on the upside.
Meeting central bankers
The meetings offer an opportunity to hear from investors, World Bank and IMF representatives and central bank officials from countries around the world. I met with a number of EM central bank officials. Among their concerns were that domestic growth and inflation data suggests that easing of rates is warranted, but their currencies have started to depreciate — significantly in some cases – versus the US dollar.
Another theme at the meetings was the progress and normalisation in sovereign debt restructuring. Several countries are moving from defaulted to performing, and there has been an increase in more market friendly governments who are willing to engage in IMF programmes. Ecuador is one of these countries. Another, Zambia, has reached an agreement with creditors. The government of Ghana recently held private discussions with a bondholder group about restructuring Eurobond debt but failed to reach a final agreement; Sri Lanka’s Eurobond debt restructuring negotiations ended in a stalemate. In both cases progress was made, however.
In general, there is investor appetite for restructuring and achieving positive outcomes, and there is more normalisation in the credit spread part of the lower-rated sovereign debt universe.
Ukraine restructuring
There is now a proactive effort to restructure Ukrainian sovereign debt in advance of the expiry of that standstill agreement. The IMF has put forward a framework for the public debt and medium-term targets for restoring sustainability. There was some concern that the recovery value would not be as high as expected.
Unconstrained and global
As unconstrained, global and active investors in the government bond market, we see compelling opportunities in the current environment, including restructuring stories. We also look to frontier markets such as Venezuela, Ecuador and Egypt or countries such as Turkey. These are idiosyncratic investment opportunities, uncorrelated to other markets that with prudent analysis can help to deliver differentiated returns for investors.
The IMF meetings highlighted some of these potential opportunities. We believe that by globally diversifying the portfolio, and by taking an active approach to choosing rates, sovereign spread or currency risk, we have the potential to deliver superior returns in our sovereign opportunities strategy.
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