Market Review

In June, hard-currency emerging-market debt (EMD) returned 0.62% [1], while local-currency EMD returned -1.08% [2]. In EM corporate debt, the total return over the month was 0.93% [3].

Despite some conflicting US data throughout the month, June left investors feeling more optimistic about inflation. The May nonfarm payrolls notably surprised on the upside, with headline (272,000) and private (229,000) payroll number well above expectations (representing gains of 180,000 and 165,000, respectively). While this suggested still-strong employment levels, evidence of cooling US inflation continued to grow. The May Consumer Price Index (CPI) print showed annual core CPI at its lowest level since April 2021. May’s Personal Consumption Expenditures (PCE) Price Index data also showed core PCE decelerating on an annual basis, falling to its lowest level since March 2021. Sentiment leaned on the positive side, with investors’ expectations for the size of US Federal Reserve (Fed) rate cuts growing from 39 basis points (bps) to 49 bps by year-end. This caused US Treasury yields to ease, with the 10-year yield and two-year yield tightening by approximately 10bps to 4.4% and 4.75%, respectively. Oil prices began the month on a weak note, but soon recovered, with Brent Crude ending June up about 4% to $84.6 per barrel.

In local-currency EMD, yields fell one basis point to 6.60% and local currency bonds generated a positive return (0.88%), while EM foreign-exchange returns were negative (-1.94%). South Africa strongly outperformed the rest of the index after the general election led to the formation of a more market-friendly government. Meanwhile, Mexico underperformed after election results in the country consolidated the power of the Morena Party but increased uncertainty over potential constitutional changes.

EM corporate debt returned 0.93% over the month. Investment grade corporates (0.88%) marginally underperformed high yield, which returned 1.00%. Africa outperformed, while the Middle East and Asia were the worst performing regions. On a sectoral basis, real estate was the top performer, while financials underperformed.

Outlook

We continue to see value in the high yield and frontier sectors where spreads and yields look attractive. However, we remain cautious where countries have challenging amortisation schedules and a significant need for market access, given higher financing costs. Several countries still trade above 1000bps, making market access difficult to justify. Nonetheless, we expect continued support from multilaterals and alternative sources, which reduces default risk and provides ample room for spread compression, as well as a fall in yields.

In EM local markets, we remain overweight Latin America due to attractive real rates in the region. Furthermore, less elevated economic growth and contained domestic wage pressures provide more room for central banks to cut. For EM corporates, credit fundamentals remain supportive. As global economic growth slows, we're likely to see downward adjustments to operational performance. However, leverage remains low and interest coverage healthy.

The asset class continues to offer good value compared with developed market credit, namely in high yield. The ‘Goldilocks’ scenario for EM combines a more aggressive rate-cutting path for the Fed with weaker US growth and dollar. The two scenarios that could lead to a risk-off environment would be a higher terminal rate, if inflation remains elevated, or markedly lower bond yields due to financial stability risks.