September was a strong month for Emerging Market Debt (EMD), with all indices gaining for the third consecutive month. Hard currency sovereign bonds (1.85%) [1] benefitted from the Federal Reserve's (Fed) rate cut, which lowered US Treasury (Treasury) yields. Sovereign spreads tightened in the risk-on environment, led by high yield, which benefitted Frontier sovereign bonds (+2.26%) [2], whilst the more defensive corporate bonds lagged behind (+1.23%) [3]. Local currency bonds led gains for the second month in a row (+3.39%) [4] due to lower yields and a weaker US Dollar.

Several themes influenced the market, including more dovish central banks. The Fed cut policy rates by 50 basis points (bps) to 4.75%-5.00%. This response reassured investors that the central bank would react quickly to economic changes, which spurred a risk-on rally. The 10-year Treasury yield fell to 3.78%, and the US Dollar weakened by 0.9%. China also announced significant monetary easing measures, including cuts to policy rates and banks' reserve requirement ratios. Metals and agriculture commodities rallied, although oil prices fell by 8.9% to $71.77 per barrel over the month, due to OPEC+'s commitment to the phased removal of output restraints.

EMD funds saw inflows for the first time since January 2023, with hard and local currency funds recording $0.2 billion and $0.5 billion, respectively. Sovereigns issued $15 billion and corporates $64 billion, marking the most active month of issuance since June 2021.

 

Hard currency sovereign bonds returned +1.85% thanks to a positive treasury return (+1.17%) and spread return (+0.67%), as spreads tightened by 27bps. Lebanon was the top performer, with bonds rallying 26% after the death of Hezbollah’s leader in an Israeli air strike spurred hopes of reform, as well as IMF engagement and debt restructuring. Meanwhile, Venezuelan bonds slumped as international pressure mounted on President Maduro over claims that he obstructed free and fair elections, including sanctions imposed by the US on Maduro-aligned officials.

Local currency sovereign bonds returned +3.39%, led by a positive currency return (+2.01%) and a positive bond return (+1.35%), as the yield on the index fell by 15bps to 6.11%. While central banks in Latin America and Central Europe continued their rate-cutting cycles, Asia local currency debt outperformed, with the ongoing currency rally fuelled further by China’s stimulus measures. Brazil bucked the global easing trend after the central bank raised interest rates amid strong consumption and above-target inflation expectations.

EM corporate bonds returned 1.23%, with high yield outperforming and investment grade lagging. Europe and Africa outperformed regionally, while the Middle East lagged due to weakness in Oil & Gas.

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Outlook

EMD performed well in September, supported by the global shift towards monetary easing led by the Fed and the resulting risk-on environment. We continue to see value in high yield and frontier markets due to attractive spreads and yields. These are supported by increased market access, continued multilateral support and progress on debt restructurings.

In EM local markets, we remain overweight in Latin America, given the attractive real rates in the region. Additionally, lower economic growth and contained domestic wage pressures provide more room for central banks to cut interest rates. For EM corporates, credit fundamentals remain supportive and net supply is expected to remain negative as EM corporates continue to pay down bonded debt. As global economic growth slows, we are likely to see downward adjustments to operational performance. However, leverage levels remain low, and interest coverage is healthy. 

The asset class continues to offer good value versus developed market credit, namely in high yield. The ‘Goldilocks’ scenario for EMD would combine a more aggressive rate-cutting path for the Fed with slower US growth and a weaker US dollar. However, overtly weak US data could stoke recession fears, and that could trigger a wave of risk aversion.