Bond outlook pieces often mention developed market monetary policy as a driver of returns, and rightly so. For emerging markets (EMs) in 2024, however, a different theme has emerged– elections. To date, voters have gone to the polls in Bangladesh, Taiwan, El Salvador, Pakistan, Senegal, India, Mexico, Turkey and South Africa. We don’t have time to run through the individual country outcomes but there are a few that warrant a closer look.

Let's turn our attention to Pakistan. In January, a civilian government came to power, pledging fiscal consolidation and promising to build foreign exchange (FX) reserves. Sound familiar? That’s because it is. Pakistan is now looking to enter a record 24th International Monetary Fund (IMF) programme. The question remains: will the outcome be different this time? The early signs are promising. Ongoing disinflation has allowed the central bank to loosen monetary policy. The balance of payments recently turned positive. But let’s not get carried away. This story is still unfolding, and we’ll keep a close eye on developments over the coming months.

In Mexico, the election of Claudia Sheinbaum, a protégé of the current president (AMLO), is expected to maintain the political status quo. Sheinbaum will need to focus on reducing the deficit from 6% of gross domestic product to a manageable level. The fiscal deficit blew out in the run-up to the election, as AMLO increased unfunded social security payments – among other social transfers – in a bid to shore up support. It certainly did the trick.

Sheinbaum will also have to reckon with Pemex, the state-owned energy company groaning under heavy debt and declining crude production. AMLO's decision to include Pemex's amortisation payments in the national budget for the first time also increased the deficit. It's hard to see how Sheinbaum will address these issues in the near future.

Democracy alive and well

Liberal democracy has come under pressure over the last few years. It was therefore encouraging to see the world’s largest democracy, India, go to the polls in a general election that was generally seen as free and fair. Such is the scale of proceedings that voting took place over six weeks. President Modi has walked away wounded but victorious. His BJP party remains the largest in congress and coalition partners are unlikely to block his planned economic initiatives.

Finally, in South Africa, the loss of the ANC’s majority for the first time since the dawn of democracy shocked the party. For the moment, things are likely to remain the same. Yet, looking ahead, there's an increased chance of the government collapsing, leading to either parliament choosing a new president or calling for new elections. Stay tuned.

What does this mean for investors?

Why are we focusing on country-specific events? Because it’s in idiosyncratic stories where we see the most compelling investment opportunities. This plays to our strength in EMD: fundamental bottom-up research to generate alpha.

At an index level, spreads across bond markets, including EMD, are tight compared with historic levels. Meanwhile, investment-grade spreads have been unattractive for several quarters. We remain underweight here.

Over a year ago, we identified value in the distressed and CCC segments. The near completion of several debt restructurings has validated this view, leading to outperformance. Recently, investors accepted Zambia’s debt restructuring deal, crafted by official creditors, the IMF and the private sector.

These deals should lead to renewed inflows into Zambia and bodes well for Ghana and Sri Lanka, which are negotiating their own deals. While we haven't seen credit-rating upgrades for CCC-rated issuers – where the most significant spread changes have occurred – further narrowing of spreads is likely should such upgrades occur.

What’s the outlook?

And so to the US Federal Reserve. Its decision to delay rate cuts has notably affected EM local bond markets, which are particularly sensitive to shifts in interest rate cut expectations. At the end of May, the EM Index was down -2.7% year-to-date.

Despite the current challenges, rate cuts in EMs are coming. Monetary policy remains tight, growth is lagging long-term averages, and base effects mean inflation should continue to fall. Despite the macro backdrop, local bond markets continue to price-in tight monetary policy. We’re holding positions and adding selectively in anticipation of the market delivering elevated returns in the coming months.

After lagging EMs in 2023, EM Corporate Debt has outperformed in the first half of the year. Fundamentals remain in good shape, reflected in the low default rate year-to-date. At the end of April, the rate stood at just 0.7%, well-below the historical average. Most defaults in this asset class are coming from China’s high-yield property sector. Like the sovereign market, spreads have been tightening recently, reaching near-historic lows. Despite this, the high absolute yield of over 7% remains appealing. For now, there seems to be little that could halt the momentum of the spread rally.

Finally, a quick word on frontier local markets. What’s changing? The answer is: a lot – and for the better. Policymakers are building external buffers, inflows into the local market are contributing to the rebuilding of FX reserves, and financing from commercial and official sources is on the rise. Meanwhile, fiscal consolidation and tightening monetary policy are helping to establish policy anchors.

Finally, high nominal yields and attractive carry in countries like Pakistan, Nigeria, Kenya, and Egypt mean that these markets are garnering investor attention and are worth considering for investment.

Important Information

Foreign securities are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

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