27 APR

2017

Fixed Income , Themen

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

Emerging Market Debt Strategy

 

External risks to EM remain elevated due to the considerable uncertainty of the impact on EM 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 commodity rout – have declined over the past 18 months and growth is recovering across EM. We retain an OW in External Debt as we remain positive on commodities and oil in particular as well as on specific idiosyncratic re-rating stories.

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 317bp, EM spreads are trading inside the 5Y average of 337bp 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 and US treasury-sensitive credits with tight valuations such as 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: still 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 EM are still below their potential growth level. We continue to see value in EM Local Rates and remain OW in selected 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 that have underperformed materially and priced in most of the political risks. Finally, we favour a Poland vs. German Bund 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 Malaysia. We are also UW Argentina (though a high yielder), based on tight valuations and a hawkish central bank policy in a high and persistent inflationary environment. We also maintain our underweight on Hungary on the back of expected reflation in 2017 and high US treasury sensitivity.