While fund flows into the asset class have struggled due to global headwinds, emerging market debt in terms of performance has been quite resilient.
Over 2023, EM hard currency indices and EM local currency indices returned low double-digit returns.
This was amid an aggressive Federal Reserve hiking cycle, heightened US treasury yield volatility, a disappointing post-Covid China reopening, looming geopolitical risks and two major wars.
The resilience of the asset class has been impressive, attributable to improving institutional strengths, hard-fought credibility of their central banks, in particular in their disciplined response to inflation, and a lengthening history of prudent macroeconomic policies.
Companies operating in these EM countries have benefited from this structural framework, enabling them to successfully access the international capital markets while at the same time developing and strengthening their local funding sources.
If US rate volatility eases, we could see EM fund flows turn positive as investors rotate back into the asset class, given the attractive yield and spread pick-up relative to developed market (DM) credits.
In addition, the technicals for the asset class remain supportive thanks to significant reduction in new external bond issuance over the past few years, combined with a prominent level of tenders, buybacks, and calls.
This has led to a shrinking EM debt stock.
Globally, it appears likely that we will see a disinflation cycle continuing through 2024. DM central banks, including the Fed, have removed their hiking bias, and are expected to begin easing monetary policy from restrictive levels this year.
Many EM central banks, which had hiked rates earlier and more aggressively than DM central banks, have already begun to ease.
On balance, investors could expect more accommodative monetary policy to support economic growth and favour the EM to DM growth differential.
China, the world’s second largest economy, should continue to grow around 5 per cent for 2024.
If needed, Beijing appears ready to increase support to prevent a sharp domestic growth slowdown. Policy support is likely to include liquidity measures, proactive fiscal policy, and monetary support.
US impact
A key trend that investors should be monitoring is market implications for the US election in November this year.
Whoever wins, the next administration likely will continue to support US domestic growth. Geopolitical risks need to be carefully monitored as they are the most likely potential source of economic headwinds.
The dollar is anticipated to somewhat rangebound over the near term, which is beneficial to the EM carry trade and dampens volatility in EM foreign currencies.
Over the medium term, broad dollar weakness is likely as the Fed begins a cutting cycle and global growth rebounds with support from China, while a deteriorating fiscal outlook in the US may deter dollar dominance.
A global recession, the US election cycle and an escalation of geopolitical conflicts are some of the key risks to EMs to monitor over 2024.
