The global environment has led to strong outflows from emerging market debt markets in 2022. Photo: Shutterstock

The global environment has led to strong outflows from emerging market debt markets in 2022. Photo: Shutterstock

Emerging market bonds have corrected sharply in 2022, reaching a 10-year low. This is the right time to enter this market, according to Jeremy Cunningham of Capital Group, though taking precautions is advised.

“The global environment has led to strong capital outflows from emerging markets debt in 2022. Rising US interest rates--and thus rising inflation in emerging markets--combined with an increase in the overall risk premium have reduced the relative attractiveness of emerging market debt to global investors, while rising US rates have directly increased the cost of funding for emerging market dollar debt issuers. Net outflows from emerging market portfolios totalled just under $100bn in the first 11 months of the year," summarises Jeremy Cunningham.

Historically, any rise in the dollar has produced bond crashes in emerging markets. With the Fed’s monetary tightening, the dollar mechanically appreciates. In this context, advising such bonds may seem paradoxical, especially as no one can say when the Fed will stop raising rates.

So this is a good time to think about allocations.
Jeremy Cunningham

Jeremy Cunninghaminvestment director - fixed incomeCapital Group

Cunningham agrees. For him, we will have to wait until the Fed has effectively finished its monetary tightening policy. But the important thing, in his view, is to “look at the market fundamentals now, ignoring the current uncertainties and high market volatility.” And while there is little chance of value in this market in six months’ time, he believes that in three to five years’ time, yield levels will be very high. “So this is a good time to think about allocations.”

Especially as he is convinced that, as soon as the Fed blows the whistle on the end of the fight against inflation, emerging countries will receive a huge amount of capital seeking investment. This flow will particularly affect those countries “with attractive real interest rates and strong external balances.”

Wide range of opportunities and risks

The emerging market is made up of around 70 to 80 countries. “That's a lot more than 30 years ago--when the last emerging market crisis occurred--when there were only a few countries, mostly in Latin America. So investors are faced with a wide range of opportunities. The question is how you build your risk. I think the best way is to adopt a bottom-up methodology. Especially as there are many risks.”

Without even mentioning geopolitical issues, the first risk that comes to mind is political risk. “When we assess the attractiveness of a specific country’s debt, the political risk within that country is absolutely essential to assess the stability and credibility of that country’s government to implement the right economic measures.”

“In terms of inflation, the impact will vary across markets. Asian markets will be less affected than Central American markets," says Cunningham.

China, Brazil and Mexico

For him, three countries have debts that look the most promising in the medium and long term. Countries that have attractive real interest rates, strong core external balances (current account and foreign direct investment) and good reserve coverage.

First, there is China, whose reopening will boost its economy--a reopening that may benefit some countries more than others, notably those in sub-Saharan Africa.

Secondly, Brazil, where the central bank has reacted very quickly to the inflation that has hit Latin America harder than other regions of the world. “With policy rates at around 14% and inflation close to 5%, we think the central bank will ease policy to bring down real yields. When you have valuations in Brazil, which is a double B rated country, around 10-11%, it becomes very attractive.”

Mexico’s business case, meanwhile, has more to do with its very high correlation to US growth. “The economic forecasts for Mexico are very compelling. In our portfolios, we use the country as an ‘investment grade allocation,’ with lower volatility and strong fundamentals.”

This story was first published in French on . It has been translated and edited for Delano.