Overweight high yielders and underweight treasury-sensitive credits in external debt

External risks to EMs remain elevated due to the considerable uncertainty of the impact on EMs of the new US administration's policies, European elections and Brexit. Emerging Markets enter this period with strong fundamentals as the main risks to the asset class – China slowdown and the commodity rout on EM have declined over the past 18 months and growth is recovering across EMs. We retain an OW in External Debt as we remain positive on commodities and oil in particular and specific idiosyncratic re-rating stories like Argentina.

Overweight high yielders and underweight treasury-sensitive credits in external debt

EMD HC risk premiums have more than recovered from the surprise result of the US presidential election. EMD does not seem to offer value on an absolute basis – at 317bps, EM spreads are trading inside the 5Y average of 337bps but relative valuation to DM HY and IG still offers value, especially in the single and double-B-rating buckets.

In the near term, technical factors are neutral-to-positive as EM sovereign supply is manageable and met by the large coupons and redemptions in Q1. YTD asset class flows are positive and we expect $20-40bn of asset class inflows in 2017.

In this context, we maintain an overweight (OW) position in high yielders with structural reform momentum and/or IMF programmes such as Argentina, Georgia and Ghana as well as select Eastern European credits such as Bulgaria and Montenegro, where valuations appear attractive. We are also overweight the energy complex, with our overweight positions in countries like Venezuela, Angola, Gabon, Azerbaijan and Kazakhstan, as we expect oil prices to recover in 2017 following the OPEC agreement in November 2016 that resulted in production cuts.

Our underweights (UW) include low beta, US treasury-sensitive credits with tight valuations such like Panama, Peru, Chile, Uruguay, the Philippines and Poland. We also aim to hold a low exposure to South Africa, which is suffering from tight valuations, domestic political transition, downgrade risks, insufficient fiscal adjustment and weak growth.

Local curves: continues to be an attractive asset class, selective approach

Local Rates will continue to benefit from EM disinflation and accommodative EM central bank policies, although the easing cycles might be shallower than expected given Fed monetary policy normalization. The EM cyclical growth recovery is also expected to continue as most EMs are still at below potential growth. We continue to see value in EM Local Rates and remain OW select high-yielders.

Supported by high real rates and constructive disinflation dynamics such as Brazil, Colombia, and Russia, we are overweight higher yielders. Accommodative monetary policies in EM and DM favour exposure to the mid- and long-end segments of these local curves.

We also prefer mid-beta bond markets like those of South Africa and Mexico, which have underperformed materially and are pricing in most political risks. Finally, we favour a Poland vs. German Bunds strategy, based on attractive multi-year valuations and limited inflationary pressures.

On the other hand, we are underweight treasury-sensitive Asian low-yielding Local Rates markets such as those of Thailand and Malaysia, which are exhibiting high US Treasury sensitivity and tight valuations.