We retain small overweights in External Debt

The month ushered in the victory of Donald Trump in the US elections, triggering a sharp rise in US Treasury yields. In this context, the emerging debt asset class suffered considerably, with external debt correcting by around 5% over the month, though the YTD performance of both the LC and HC markets remains positive.

External risks to EM have increased, as the new US administration is expected to pursue more restrictive trade policies abroad and reflationary fiscal policies at home. The EMD enters this period of elevated uncertainty with strong fundamentals, as the main risks to the asset class – China slowdown and commodity rout – have declined YTD. We retain small overweights in External Debt, as the impact from the new US administration's policies will be mixed – positive on commodity exporters and negative on low-cost manufacturing exporters.

External debt: Balanced approach to the energy complex, underweight treasury-sensitive credits

As a result of EMD HC risk premiums increasing in November, absolute and relative valuations offer better entry points but are still not trading at excessively attractive levels (at 356 bps, EM spread-trading is only slightly above the 5Y average of 340 bps).

In the near term, technical factors are less supportive, as investors have started taking profits on their EMD allocations. We expect asset-class inflows to restart in early 2017 as valuations are further restored, market participants get better visibility on the new US administration's policies, and the Fed's hiking cycle is more fully priced in.

In this context, we maintain an overweight position in high yielders with idiosyncratic drivers such as Argentina, Brazil and and Ghana, as well as select Eastern European credits such as Serbia,  Bulgaria, Croatia and Montenegro, where valuations appear attractive. We hold a balanced allocation to the energy complex, in which our overweight positions in countries like Venezuela and Ecuador, where elevated yields compensate for the deteriorating fundamentals, are offset by underweight positions in Nigeria and Malaysia, where valuations are, in relative terms, tight.

Our underweights include low beta and US treasury-sensitive credits with tight valuations such as China, Peru, Chile and Panama. We also aim to hold a low exposure to Middle East and North African countries such as Lebanon, which suffers from elevated political risk and less supportive technicals, and Oman, where supply risk is present.

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

Local Rates will continue to benefit from EM disinflation and accommodative EM central bank policies, although easing cycles might be shallower than expected prior to the US elections. EM cyclical growth recovery is also expected to continue, as most EMs still have the potential for growth. We continue to see value in EM Local Rates and remain overweight to select segments that exhibit elevated yields.

Consequently, we maintain our overweight in high yielders supported by high real rates and constructive disinflation dynamics such as Brazil, Colombia, Russia and Indonesia. Accommodative monetary policies in emerging and developed markets favour exposure to the mid and long end of the curves.

On the other hand, we are underweight Asian low yielders such as Thailand and Malaysia, which are exhibiting high US Treasury sensitivity and tight valuations. We hold limited exposure to Central and Eastern European low-yielders such as Poland, Hungary and Romania, as these also trade with tight valuations and high sensitivity to US Treasuries.